o^— 2 


S3 


'i_ 


10 


PREFACE 

This  series  of  books  owes  its  existence  to  the  generosity  of 
Messrs.  Hart,  Schaffner  &  Marx,  of  Chicago,  who  have 
shown  a  special  interest  in  trying  to  draw  the  attention  of 
American  youth  to  the  study  of  economic  and  commercial 
subjects.  For  this  purpose  they  have  delegated  to  the  un- 
dersigned committee  the  task  of  selecting  or  approving  of 
topics,  making  announcements,  and  awarding  prizes  an- 
nually for  those  who  wish  to  compete. 

For  the  year  ending  June  1,  1917,  there  were  offered: 

In  Class  A,  which  included  any  American  without  re- 
striction, a  first  prize  of  $1000,  and  a  second  prize  of  $500. 

In  Class  B,  which  included  any  who  were  at  the  time 
undergraduates  of  an  American  college,  a  first  prize  of  $300, 
and  a  second  prize  of  $200. 

Any  essay  submitted  in  Class  B,  if  deemed  of  sufficient 
merit,  could  receive  a  prize  in  Class  A. 

The  present  volume,  submitted  in  Class  A,  was  awarded 
second  prize  in  that  class. 

J.  Laurence  Laughlin,  Chairman 

University  of  Chicago 
J.  B.  Clark 

Columbia  University 
Henry  C.  Adams 

University  of  Michigan 
Edwin  F.  Gay 

N.Y.  Evening  Post 
Theodore  E.  Burton 

New  York  City 


447383 


^ 


AUTHOR'S  PREFACE 

There  is  little  that  is  fundamentally  new  in  this  book'  It 
represents  an  attempt  to  state  the  essential  principles  of 
the  conventional  economic  doctrine  more  accurately,  and 
to  show  their  implications  more  clearly,  than  has  previ- 
ously been  done.  That  is,  its  object  is  refinement,  not  re-  , 
construction;  it  is  a  study  in  "pure  theory."  The  motive 
back  of  its  presentation  is  twofold.  In  the  first  place, 
the  writer  cherishes,  in  the  face  of  the  pragmatic,  philistine 
tendencies  of  the  present  age,  especially  characteristic  of 
the  thought  of  our  own  country,  the  hope  that  careful, 
rigorous  thinking  in  the  field  of  social  problems  does  after 
all  have  some  significance  for  human  weal  and  woe.  In  the 
second  place,  he  has  a  feeling  that  the  "practicalism"  of 
the  times  is  a  passing  phase,  even  to  some  extent  a  pose; 
that  there  is  a  strong  undercurrent  of  discontent  with  loose 
and  superficial  thinking  and  a  real  desire,  out  of  sheer  in- 
tellectual self-respect,  to  reach  a  clearer  understanding  of 
the  meaning  of  terms  and  dogmas  which  pass  current  as 
representing  ideas.  For  the  first  of  these  assumptions  a  few 
words  of  elaboration  or  defense  may  be  in  place,  in  antici- 
pation of  the  essay  itself. 

The  "practical "  justification  for  the  study  of  general  eco- 
nomics is  a  belief  in  the  possibility  of  improving  the  qual- 
ity of  human  life  through  changes  in  the  form  of  organiza- 
tion of  want-satisfying  activity.  More  specifically,  most 
projects  of  social  betterment  involve  the  substitution  of 
some  more  consciously  social  or  political  form  of  control  for 
private  property  and  individual  freedom  of  contract.  The 
assumption  underlying  such  studies  as  the  present  is  that 
changes  of  this  character  will  offer  greater  prospect  of  pro- 
ducing real  improvement  if  they  are  carried  out  in  the  light 


viii  AUTHOR'S  PREFACE 

of  a  clear  understanding  of  the  nature  and  tendencies  of 
the  system  which  it  is  proposed  to  modify  or  displace.  The 
essay,  therefore,  endeavors  to  isolate  and  define  the  essen- 
tial characteristics  of  free  enterprise  as  a  system  or  method 
of  securing  anddirectingcooperative  effort  in  a  social  group. 
rAs  a  necessary  condition  of  success  in  this  endeavor  it  is 
[  assumed  that  the  description  and  explanation  of  phe- 
I  nomena  must  be  radically  separated  from  all  questions 
\<$  defense  or  criticism  of  the  system  under  examination. 
By  means  of  first  showing  what  the  system  is,  it  is  hoped 
that  advance  may  be  made  toward  discovering  what  such 
a  system  can,  and  what  it  cannot,  accomplish.  A  closely 
related  aim  is  that  of  formulating  the  data  of  the  problem  of 
economic  organization,  the  unchangeable  materials  with 
which,  and  conditions  under  which,  any  machinery  of  or- 
ganization has  to  work.  A  sharp  and  clear  conception  of 
these  fundamentals  is  viewed  as  a  necessary  foundation  for 
answering  the  question  as  to  what  is  reasonably  to  be  ex- 
pected of  a  method  of  organization,  and  hence  of  whether 
the  system  as  such  is  to  be  blamed  for  the  failure  to  achieve 
ideal  results,  of  where  if  at  all  it  is  at  fault,  and  the  sort 
of  change  or  substitution  which  offers  sufficient  chance  for 
improvement  to  justify  experimentation. 
/  The  net  result  of  the  inquiry  is  by  no  means  a  defense  of 
/  the  existing  order.  On  the  contrary,  it  is  probably  to  em- 
phasize the  inherent  defects  of  free  enterprise.  But  it  must 
be  admitted  that  careful  analysis  also  emphasizes  the  fun- 
damental difficulties  of  the  problem  and  the  fatuousness 
of  over-sanguine  expectations  from  mere  changes  in  social 
machinery.  Only  this  foundation-laying  is  within  the  scope 
of  this  study,  or  included  within  the  province  of  economic 
theory.  The  final  verdict  on  questions  of  social  policy 
depends  upon  a  similar  study  of  other  possible  systems  of 
organization  and  a  comparison  of  these  with  free  enterprise 
in  relation  to  the  tasks  to  be  accomplished.  This  one  "con- 
clusion" may  be  hazarded,  that  no  one  mode  of  organiza- 


AUTHOR'S  PREFACE  ix 

tion  is  adequate  or  tolerable  for  all  purposes  in  all  fields. 
In  the  ultimate  society,  no  doubt,  every  conceivable  type  of 
organization  machinery  will  find  its  place,  and  the  problem 
takes  the  form  of  defining  the  tasks  and  spheres  of  social 
endeavor  for  which  each  type  is  best  adapted. 

The  particular  technical  contribution  to  the  theory  of 
free  enterprise  which  this  essay  purports  to  make  is  a  fuller 
and  more  careful  examination  of  the  role  of  the  entrepreneur 
or  enterpriser,  the  recognized  "central  figure"  of  the  sys- 
tem, and  of  the  forces  which  fix  the  remuneration  of  his 
special  function.  The  problem  of  profit  was  suggested  to 
the  writer  as  a  suitable  topic  for  a  doctoral  dissertation 
in  the  spring  of  1914  by  Dr.  Alvin  Johnson,  then  Professor 
of  Economics  in  Cornell  University.  The  study  was  chiefly 
worked  out  under  the  direction  of  Professor  Allyn  A.  Young 
after  Dr.  Johnson  left  Cornell.  My  debt  to  these  two  teach- 
ers I  can  only  gratefully  acknowledge.  Since  the  accept- 
ance of  the  essay  as  a  thesis  at  Cornell  in  June,  1916,  and 
its  submission  in  the  Hart,  Schaffner  &  Marx  competition 
in  1917,  it  has  been  entirely  rewritten  under  the  editorial 
supervision  of  Professor  J.  M.  Clark,  of  the  University  of 
Chicago.  I  have  also  profited  much  by  discussions  with 
Professor  C.  O.  Hardy,  my  colleague  at  the  same  institu- 
tion, and  by  access  to  his  unpublished  "Readings  on  Risk 
and  Risk-Bearing."  Professor  Jacob  Viner,  of  the  Uni- 
versity of  Chicago,  has  kindly  read  the  proof  of  the  entire 
work.  My  obligations  to  various  economists  through 
their  published  work  are  very  inadequately  shown  by 
text  and  footnote  references,  but  are  too  comprehensive 
and  indefinite  to  express  in  detail. 

F.  H.  Knight 

Iowa  City,  Iowa 

January,  1921 


I3L7S1   I* 


CONTENTS 

PART  ONE 

INTRODUCTORY 

Chapter  I.  The  Place  of  Profit  and  Uncertainty 
in  Economic  Theory  3 

The  nature  and  necessity  of  a  deductive  science  of  economics  — 
Analogy  of  physical  science  —  Necessity  of  emphasizing  the 
abstract  character  of  hypotheses  —  Thought  means  analysis 
and  analysis  abstraction  —  The  assumption  of  perfect  com- 
petition —  Profit  absent  —  The  conditions  of  perfect  competi- 
tion include  especially  perfect  knowledge,  and  profit  is  to  be  ex- 
plained by  uncertainty  —  Plan  of  the  book. 

Chapter  II.  Theories  of  Profit;  Change  and  Risk 
in  Relation  to  Profit  22 

Historical  sketch  of  the  treatment  of  profit  in  economic  litera- 
ture —  Special  consideration  of  the  Dynamic  and  the  Risk  the- 
ories —  The  former  confuses  the  effects  of  change  with  those  of 
the  uncertainty  connected  with  change  —  The  latter  falls  into 
confusion  by  failing  to  distinguish  between  risk  in  the  sense  of 
a  measurable  probability  and  an  uncertainty  which  cannot  be 
measured  —  Change  according  to  a  known  law  does  not  give  rise 
to  profit,  nor  does  risk  if  measurable,  since  it  can  be  eliminated 
by  insurance  or  some  equivalent  device. 

PART  TWO 

PERFECT  COMPETITION 

Chapter  III.  The  Theory  of  Choice  and  of  Ex- 
change 51    Is 

Wants,  and  the  economic  order  as  a  mechanism  for  organizing 
want-satisfying  activity  —  Conflict  of  wants  —  Resources,  and 
their  use  to  satisfy  a  plurality  of  wants  —  Utility  and  Dimin- 
ishing Utility  —  Simple  choices;  the  boy  and  the  berries;  Crusoe 
and  the  Crusoe  economy;  the  production  and  exchange  of  goods 
under  simplified  social  conditions  —  The  problem  that  of  com- 
bining alternatives  —  Pleasure  and  pain  relative  —  Cost  is 
a  sacrificed  alternative  —  The  true  significance  of  resources  and 
resource  costs  —  Formulation  of  the  relations  in  functions, 
curves  and  equilibria. 


xii  CONTENTS 

,   Chapter  IV.  Joint  Production  and  Capitalization  94 
v 

The  use  of  a  plurality  of  kinds  of  resource  in  producing  various 
commodities  and  the  resulting  problem  of  organization  —  The 
law  of  diminishing  returns,  analogue  of  the  law  of  diminishing 
utility  —  The  imputation  of  product- values  to  resources  or 
cost-goods  and  resultant  placing  of  the  latter  to  maximize  their 
yield  —  Critique  of  the  productivity  theory  —  The  values  of 
productive  services  in  terms  of  demand  and  supply  —  No  valid 
classification  of  productive  agencies  into  "factors"  is  possible 
—  The  r61e  of  time  in  production  and  the  fallacy  of  time- 
preference. 

Chapter  V.  Change  and  Progress  with  Uncer- 
^      taint  y  Absent  141 

The  meaning  of  static  conditions  and  the  forms  of  progress  — 
Question  of  classifying  productive  agencies  along  conventional 
tripartite  lines  —  Changes  in  supply  and  demand  of  productive 
goods  and  in  the  distributive  shares  —  Question  of  progress 
toward  equilibrium  levels  —  All  modes  of  progress  represent 
alternative  methods  of  investing  present  resources  for  a  future 
gain  —  With  uncertainty  absent  the  rate  of  return  would  be 
equal  in  all  these  fields  —  Contrast  with  present  facts  —  The 
nature  of  interest  as  a  peculiar  form  of  income,  distinguishable 
from  rent. 

Chapter  VI.  Minor  Prerequisites  for  Perfect 
Competition  174 

Brief  consideration  of  conditions  requisite  for  perfect  competi- 
tion other  than  the  absence  of  uncertainty  —  Divisibility  of 
elements  in  the  adjustment  —  Lack  of  moral  connotation  of 
the  term  "productivity"  —  Monopoly;  various  forms;  is  pro- 
ductive in  the  economic  sense  —  Tendency  of  a  competitive 
system  toward  monopoly  and  a  universal  dead-lock. 

PART  THREE 

IMPERFECT  COMPETITION  THROUGH  RISK  AND 
UNCERTAINTY 

Chapter  VII.  The  Meaning  of  Bisk  and  Uncer- 
tainty 197 

Outlines  of  a  theory  of  knowledge  —  The  r61e  of  consciousness 
in  behavior  —  Conduct  is  forward-looking  and  the  problem  of 
knowledge  is  prediction  —  Knowledge  of  the  future  depends  on 
the  fact  that  experience  can  be  analyzed  into  the  behavior  of  ob- 


CONTENTS  xiii 

jects  which  maintain  their  identity  —  But  there  are  too  many 
of  these  for  our  intelligence  to  handle,  so  we  depend  on  inferring 
one  mode  of  behavior  from  another;  i.e.,  upon  constancy  in  asso- 
ciation of  properties  —  Generally  speaking,  exhaustive  and 
quantitative  analysis  is  impossible,  and  we  "estimate"  —  Com- 
monly there  is  a  diversity  in  the  possible  modes  of  behavior  to 
be  inferred,  and  we  reason  in  terms  of  "probability"  of  various 
outcomes  —  Probability  a  priori  vs.  statistical  —  Errors  in 
judgment  usually  not  susceptible  to  objective  evaluation  on 
any  ground,  though  they  are  estimated  as  probabilities  —  The 
"risks"  which  give  rise  to  profit  are  chiefly  of  the  nature  of 
chances  of  error  in  judgment,  and  hence  not  measurable,  be- 
cause too  unique  to  form  into  classes. 

Chapter    VIII.    Structures   and  Methods  for 
Meeting  Uncertainty  233 

Attitudes  toward  uncertainty  —  Variable  factors  —  Free  enter- 
prise —  The  economic  organization  deals  with  uncertainty  by 
reducing  it  or  specializing  the  function  of  meeting  it  —  The 
chief  method  of  reduction  is  by  consolidation,  though  impor- 
tant structures  exist  for  perfecting  information  and  for  the 
direct  control  of  the  future  —  Insurance  the  chief  device  for 
consolidation  —  Speculation  specializes  risk,  but  is  fully  as 
important  as  a  means  of  consolidation  —  Large-scale  operation, 
especially  the  corporation  —  Promotion. 

Chapter  IX.  Enterprise  and  Profit  264 

Introduction  of  uncertainty  into  a  perfectly  equilibrated  static 
society  —  Specialization  of  the  function  of  management  and 
risk-assumption  —  Contractual  income  and  residual  income  — 
Conditions  which  control  the  amount  of  the  profit  share,  chiefly 
timidity  vs.  optimism  of  entrepreneurs,  especially  in  estimating 
their  own  powers  —  Supply  and  demand  of  entrepreneur 
ability. 

Chapter  X.   Enterprise  and  Profit   (continued) 
The  Salaried  Manager  291 

Indirectness  of  knowledge  and  control  —  We  generally  judge  the 
capacity  of  some  one  else  to  judge  for  us  and  not  our  problem 
itself  —  In  the  same  way  we  get  things  done  by  getting  others 
to  do  them  —  The  characteristic  quality  of  the  executive  is 
judgment  of  men  —  The  final  control  is  the  selection  of  men  to 
control  in  business  organization,  and  this  is  inseparable  from 
responsibility  —  The  distribution  of  authority  and  responsibil- 
ity in  the  modern  business  world. 


xiv  CONTENTS 

Chapter  XI.  Uncertainty  and  Social  Progress     313 

Change,  the  main  source  of  uncertainty,  is  the  source  of  the 
problem  of  control  —  Uncertainty  in  the  investment  of  re- 
sources gives  rise  to  a  separation  of  the  function  of  investment 
from  that  of  saving  —  The  theory  of  interest  —  The  uncer- 
tainty element  in  relation  to  the  various  forms  of  progressive 
change  —  Complicated  problems  arising  out  of  the  capitaliza- 
tion of  profits  — The  permanence  of  profit;  friction,  and  mo- 
bility. 

Chapter  XII.  Social  Aspects  of  Uncertainty  and 
Profit  347 

All  methods  of  reducing  or  redistributing  uncertainty  involve 
costs  —  The  extent  to  which  they  should  be  carried  depends 
upon  how  far  uncertainty  as  such  is  undesirable  —  Free  enter- 
prise concentrates  control  and  responsibility  in  the  hands  of 
property-owners,  and  a  small  class  of  these  —  Contrast  between 
free  enterprise  and  freedom  —  From  the  standpoint  of  efficiency 
alone  it  is  fairly  clear  that  men  work  more  interestedly  and 
effectively  for  an  uncertain  than  for  a  certain  reward  —  Ques- 
tion of  the  aggregate  amount  of  the  profit  share  —  All  evidence 
indicates  that  it  is  negative  —  Question  of  abolishing  free  enter- 
prise in  favor  of  some  other  system  —  Largely  a  problem  of  get- 
ting those  in  control  of  economic  activity  to  feel  an  independent 
creative  spirit  —  The  great  difficulty  of  control  beyond  one's 
own  life-time;  social  continuity  and  the  family  problem. 

Index  377 


RISK,  UNCERTAINTY,  AND  PROFIT 

PART  I 

INTRODUCTORY 


RISK,  UNCERTAINTY,  AND  PROFIT 


CHAPTER  I 

THE  PLACE  OF  PROFIT  AND  UNCERTAINTY  IN 
ECONOMIC  THEORY 

Economics,  or  more  properly  theoretical  economics,  is 
the  only  one  of  the  social  sciences  which  has  aspired  to  the 
distinction  of  an  exact  science.  To  the  extent  that  it  is  an 
exact  science  it  must  accept  the  limitations  as  well  as  share 
the  dignity  thereto  pertaining,  and  it  thus  becomes  like 
physics  or  mathematics  in  being  necessarily  somewhat 
abstract  and  unreal.  In  fact  it  is  different  from  physics  in 
degree,  since,  though  it  cannot  well  be  made  so  exact,  yet 
for  special  reasons  it  secures  a  moderate  degree  of  exactness 
only  at  the  cost  of  much  greater  unreality.  The  very  con- 
ception of  an  exact  science  involves  abstraction;  its  ideal  is 
analytic  treatment,  and  analysis  and  abstraction  are  vir- 
tually synonyms.  We  have  given  us  the  task  of  reducing  to 
order  a  complex  mass  of  interrelated  changes,  which  is 
to  say,  of  analyzing  them  into  uniformities  of  sequence  or 
behavior,  called  laws,  and  the  isolation  of  the  different 
elementary  sequences  for  separate  study. 

Sometimes  the  various  elementary  constituents  of  our 
complex  phenomenon  are  met  with  in  nature  in  isolation 
complete  or  partial,  and  sometimes  artificial  experiments 
can  be  devised  to  present  them  either  alone  or  with  attend- 
ant conditions  subject  to  control.  The  latter  is,  of  course, 
the  characteristic  procedure  of  physical  science.  Its  applica- 
tion to  the  study  of  industrial  society  is,  however,  generally 
impracticable.   Here  we  must  commonly  search  for  man- 


4  RISK,  UNCERTAINTY,  AND  PROFIT 

ifestaiious  of  the  Various  factors  in  our  complex,  under 
varying  associations,  or  rely  upon  intuitive  knowledge  of 
general  principles  and  follow  through  the  workings  of  in- 
dividual chains  of  sequence  by  logical  processes. 

The  application  of  the  analytic  method  in  any  class  of 
problems  is  always  very  incomplete.  It  is  never  possible  to 
deal  in  this  way  with  a  very  large  proportion,  numerically 
speaking,  of  the  vast  complexity  of  factors  entering  into  a 
normal  real  situation  such  as  we  must  cope  with  in  practi- 
cal life.  The  value  of  the  method  depends  on  the  fact  that 
in  large  groups  of  problem  situations  certain  elements  are 
common  and  are  not  merely  present  in  each  single  case,  but 
in  addition  are  both  few  in  number  and  important  enough 
largely  to  dominate  the  situations.  The  laws  of  these  few 
elements,  therefore,  enable  us  to  reach  an  approximation 
to  the  law  of  the  situation  as  a  whole.  They  give  us  state- 
ments of  what  "tends"  to  hold  true  or  "would"  hold 
true  under  "ideal"  conditions,  meaning  merely  in  a  situa- 
tion where  the  numerous  and  variable  but  less  important 
"other  things"  which  our  laws  do  not  take  into  account 
were  entirely  absent. 

Thus,  in  physics,  the  model  and  archetype  of  an  exact 
science  of  nature,  a  relatively  small  and  workable  number 
of  laws  or  principles  tell  us  what  would  happenjf  simplified 
conditions  be  assumed  and  all  disturbing  factors  elimi- 
natedt  The  simplified  conditions  include  specifications  as 
to  dimensions,  mass,  shape,  smoothness,  rigidity,  elasticity 
and  properties  generally  of  the  objects  worked  with, 
specifications  usually  quite  impossible  to  realize  in  fact, 
yet  absolutely  necessary  to  make,  while  the  "disturbing 
factors  "  are  simply  anything  not  included  in  the  specifica- 
tions, and  their  actual  elimination  is  probably  equally 
impossible  to  realize,  and,  again,  equally  necessary  to 
assume.  Only  thus  could  we  ever  obtain  "laws,"  de- 
scriptions of  the  separate  elements  of  phenomena  and  their 
separate  behavior.  And  while  such  laws,  of  course,  never 


IN  ECONOMIC  THEORY  5 

accurately  hold  good  in  any  particular  case,  because  they 
are  incomplete,  not  including  all  the  elements  in  the  case, 
yet  they  enable  us  to  deal  with  practical  problems  intelli- 
gently because  they  are  approximately  true  and  we  know 
how  to  discount  their  incompleteness.  Only  by  such  ap- 
proximations, reached  by  dealing  analytically  with  the 
more  important  and  more  universal  aspects  of  phenom- 
ena, could  we  ever  have  attained  any  intelligent  concep- 
tion of  the  behavior  of  masses  of  matter  in  motion  and 
secured  our  present  marvelous  mastery  over  the  forces  of 
nature. 

In  a  similar  way,  but  for  various  reasons  not  so  com- 
pletely and  satisfactorily,  we  have  developed  a  historic 
body  of  theoretical  economics  which  deals  with  "tenden- 
cies"; i.e.,  with  what  "would"  happen  under  simplified 
conditions  never  realized,  but  always  more  or  less  closely 
approached  in  practice.  But  theoretical  economics  has 
been  much  less  successful  than  theoretical  physics  in 
making  the  procedure  useful,  largely.  faBfi&HQfl  ft  ^a,s  tufed 
to  make  its  nature  and  limitations  explicit  and  jilear.  It 
studies  what  would  happen  under  "perfect  competition," 
noting  betimes  respects  in  which  competition  is  not  per- 
fect; but  much  remains  to  be  done  to  establish  a  systematic 
and  coherent  view  of  what  is  necessary  to  perfect  competi- 
tion, just  how  far  and  in  what  ways  its  conditions  deviate 
from  those  of  real  life  and  what  "corrections"  have  ac- 
cordingly to  be  made  in  applying  its  conclusions  to  actual 
situations.1 

The  vague  and  unsettled  state  of  ideas  on  this  subject  is 
manifest  in  the  difference  of  opinion  rife  among  economists 
as  to  the  meaning  and  use  of  theoretical  methods.  At 
one  extreme  we  have  mathematical  economists  and  pure 
theorists  2  to  whom  little  if  anything  outside  of  a  closed 

1  Cf .  Mackenzie,  Introduction  to  Social  Philosophy,  p.  58.  Also  Bagehot, 
Economic  Studies,  no.  1:  "The  Presuppositions  of  English  Political 
Economy." 

2  There  are  three  types  or  schools  of  mathematical  economic  theory. 


6  RISK,  UNCERTAINTY,  AND  PROFIT 

system  of  deductions  from  a  very  small  number  of  prem- 
ises assumed  as  universal  laws  is  to  be  regarded  as 
scientific  economics  at  all.  At  the  other  extreme  there  is 
,,  certainly  a  strong  and  perhaps  growing  tendency  to  re- 
pudiate abstraction  and  deduction  altogether,  and  insist 
upon  a  purely  objective,  descriptive  science.  And  in  be- 
tween are  all  shades  of  opinion. 

In  the  present  writer's  view  the  correct  "middle  way" 
between  these  extreme  views,  doing  justice  to  both,  is  not 
hard  to  find.  An  abstract  deductive  system  is  only  one 
small  division  of  the  great  domain  of  economic  science, 
but  there  is  opportunity  and  the  greatest  necessity  for 
cultivating  that  field.  Indeed,  in  our  analogy,  theoret- 
ical mechanics  is  a  very  small  section  of  the  science  of 
physical  nature;  but  it  is  a  very  fundamental  section,  in  a 
sense  the  "first"  of  all,  the  foundation  and  prerequisite  of 
those  that  follow.  CAnd  this  also  may  very  well  hold  good 
of  a  body  of  "pure  theory"  in  economics;  it  may  be  that  a 
small  step,  but  the  first  step,  toward  a  practical  compre- 
hension of  the  social  system  is  to  isolate  and  follow  out  to 
their  logical  conclusion  a  relatively  small  number  of  fun- 
damental tendencies  discoverable  in  it.  1  There  is  abundant 
need  for  the  use  of  both  deduction  and  induction  in  eco- 
nomics as  in  other  sciences,  if  indeed  the  two  methods  are 
theoretically  separable.  As  Mill  has  well  argued 1  we  must 
reason  deductively  as  far  as  possible,  always  collating  our 
conclusions  with  observed  facts  at  every  stage.  Where  the 
data  are  too  complex  to  handle  in  this  way  induction  must 
be  applied  and  empirical  laws  formulated,  to  be  connected 
deductively  with  the  general  principles  of  "ethology" 
(we  should  now  say  simply  "human  behavior").  Em- 
connected  with  the  names  of  Cournot,  Jevons,  and  Walras  respectively. 
Dr.  Vilfredo  Pareto,  of  the  University  of  Lausanne  (successor  of  Walras), 
is  now  the  most  prominent  exponent  of  the  mathematical  method.  Among 
"literary"  pure  theorists,  Wicksteed,  Schumpeter,  and  Pantaleoni  stand 
out. 

1  Logic,  book  vi,  chaps,  ix  and  x. 


/ 


IN  ECONOMIC  THEORY  7 

phasis  being  laid  on  the  provisos,  in  both  cases,  that  in 
using  deduction  the  conclusions  must  be  constantly  checked 
with  facts  by  observation  and  premises  revised  accordingly, 
while  the  empirical  laws  resulting  from  induction  must  in 
turn  be  shown  to  follow  from  the  general  principles  of  the 
science  before  they  can  be  credited  with  much  significance 
or  dependability,  we  see  that  there  is  little  divergence  left 
between  the  two  methods.1 

1  The  relations  between  deduction  and  induction  are  intimate,  and  a 
rigid  separation  or  contrast  between  the  two  methods  is  misleading.  A 
more  careful  study  of  the  fundamentals  of  scientific  method  will  be  under- 

-  taken  hereafter  (chapter  vii).  We  shall  see  that  there  is  ultimately  no 
,guch  fact  as  deduction  as  commonly  understood,  that  inference  is  from 
particulars  to  particular,  and  that  generalization  is  always  tentative  and 
a  mere  labor-saving  device.  The  fact  is,  however,  that  we  can  study  facts 

•  intelligently  and  fruitfully  only  in  the  light  of  hypotheses,  while  hypothe- 
seshave  value  more  orjess.,  in  proportion  to  theamount  of  antecedent 
concrete  "Knowledge  of  fact  on  which  they  are  teased.  The  actual  pro- 
cedure~of  science  thus  consists  of  making  and  testing  hypotheses.-]  The 
first  hypotheses  in  any  rleld  are  usually  the  impressions  of  "common 
sense";  i.e.,  of  that  superficial  knowledge  forced  upon  intelligence  by 
direct  contact  with  the  world.  Study,  in  the  light  of  any  hypothesis, 
corrects  or  refutes  the  guiding  generalization  and  suggests  new  points  of 
view,  to  be  criticized  and  tested  in  the  same  way,  and  so  the  organization 
of  the  material  proceeds.  The  importance  of  generalization  arises  from 
the  fact  that  as  our  minds  are  built,  it  is  nearly  fruitless  to  attempt  to 
observe  phenomena  unless  we  approach  them  with  questions  to  be  an- 
swer id.  This  is  what  a  hypothesis  really  is,  a  question.  Superficial  ob- 
servation suggests  questions  which  study  answers.  If  and  so  long  as  it 
answers  a  question  affirmatively  and  the  answer  is  not  contradicted  by 
the  test  of  practical  application  or  casual  observation,  we  have  a  law  of 
nature,  a  truth  about  our  environment  which  enables  us  to  react  intelli- 
gen  ly  to  it  in  our  conduct. 

There  is,  then,  little  if  .any  use  for  induction  in  the  Baconian  sense  of  an 
exhaustive  collection  and  collation  of  facts,  though  in  some  cases  this 
ma,'  be  necessary  and  fruitful.  On  the  other  hand,  there  is  equally  little 
use  for  deduction  taken  as  doing  more  than  suggesting  hypotheses,  sub- 
ject to  verification.  It  is  to  be  noted,  however,  that  our  common-sense 
generalizations  have  a  very  high  degree  of  certainty  in  some  fields,  giving 
us,  in  regard  to  the* external  world,  for  instance,  the  "axioms"  of  mathe- 
matics. Even  more  important  in  the  present  connection  is  the  r61e  of 
common  sense  or  intuition  in  the  study  of  human  phenomena.  Observa- 
tion and  intuition  are,  indeed,  hardly  distinguishable  operations  in  much 
of  the  field  of  human  behavior.  Our  knowledge  of  ourselves  is  based  on 


8  RISK,  UNCERTAINTY,  AND  PROFIT 

The  method  of  economics  is  simply  that  of  any  field  of 
inquiry  where  analysis  is  in  any  degree  applicable  and  any- 
thing more  than  mere  description  possible.  It  is  the  scien- 
tific method,  the  method  of  successive  approximations.1 
The  study  will  begin  with  a  theoretical  branch  dealing  with 
*fl  ?nly  the  most  general  aspects  of  the  subject  matter,  and 
proceed  downward  through  a  succession  of  principles  ap- 
plicable to  more  and  more  restricted  classes  of  phenomena. 
How  far  the  process  is  carried  will  be  a  matter  of  taste  and 
of  the  practical  requirements  of  any  problem.  In  science 
generally  it  does  not  pay  to  elaborate  laws  of  a  very  great 
degree  of  accuracy  of  detail.  When  the  number  of  factors 
taken  into  account  in  deduction  becomeslarge,  the  process 
rapidly  becomes  unmanageable  and  errors  creep  in,  while 
the  results  lose  in  generality  of  application  more  signifi- 
cance than  they  gain  by  the  closeness  of  approximation  to 
fact  in  a  given  case.    It  is  better  to  stop  dealing  with  ele- 

introspective  observation,  but  is  so  direct  that  it  may  be  called  intuitive. 
Its  extension  to  our  fellow  human  beings  is  also  based  upon  the  interpre- 
tation of  the  communicative  signs  of  speech,  gesture,  facial  expression, 
etc.,  far  more  than  upon  direct  observation  of  behavior,  and  this  process 
of  interpretation  is  highly  instinctive  and  subconscious  in 'character. 
Many  of  the  fundamental  laws  of  economics  are  therefore  properly  "in- 
tuitive" to  begin  with,  though  of  course  always  subject  to  correction  by 
induction  in  the  ordinary  sense  of  observation  and  statistical  treatment 
of  data. 

These  brief  statements  must  not  be  thought  of  as  dealing  with  philo- 
sophical problems.  The  writer  is,  like  Mill,  an  empiricist,  holding  that  all 
general  truths  or  axioms  are  ultimately  inductions  from  experience.  By 
induction  as  a  method  is  meant  deliberate,  scientific  induction,  the  plar  ned 
study  of  instances  for  the  purpose  of  ascertaining  their  "law."  And  de- 
duction means  reaching  new  truth  by  the  application  of  general  law  i  to 
particular  cases.  In  the  present  view  both  of  these  processes  are  regar  ded 
as  suggestive  merely,  exhaustive  induction  and  conclusive  deduction  be- 
ing alike  impossible. 

1  The  reader  will  recall  Comte's  arrangement  of  the  sciences  in  the 
order  of  generality  of  the  principles  they  establish.  Mathematics,  1  he 
properties  of  space  and  of  quantity  in  the  abstract,  is  applicable  to  all 
phenomena  —  and  tells  us  correspondingly  little  about  any  of  them. 
The  laws  of  matter,  of  living  matter,  etc.,  are  less  general  and  more  con- 
cretely real.  The  same  principles  are  applicable  within  any  grand  divi- 
sion of  knowledge. 


IN  ECONOMIC  THEORY  9 

ments  separately  before  they  get  too  numerous  and  deal 
with  the  final  stages  of  the  approximation  by  applying 
corrections  empirically  determined. 

tJThe  theoretical  method  in  its  pure  form  consists,  then,  y 
in  the  complete  and  separate  study  of  general  principles,  | 
with  the  rigid  exclusion  of  all  fluctuations,  modifications,  /  «^ 
and  accidents  of  all  sorts  due  to  the  influence  of  factors/ 
less  general  than  those  under  investigation  at  any  particular  \ 
stage  of  the  inquiry  jOur  question  relates  to  the  advisability 
of  using  this  method  in  a  tolerably  rigid  form  in  economics. 
The  answer  to  this  question  depends  on  whether  in  the 
phenomena  to  be  studied  general  principles  can  in  fact  be 
found  of  sufficient  constancy  and  importance  to  justify 
their  careful  isolation  and  separate  study.   The  writer  is 
strongly  of  the  opinion  that  the  question  must  be  an- 
swered affirmatively.  Economics  is  the  study  of  a  particu- 
lar form  of  organization  of  human  want-satisfying  activity  CA*9* 
which  has  become  prevalent  in  Western  nations  and  spread  £u>w 
over  the  greater  part  of  the  field  of  conduct.  It  is  called    a  j 
free  enterprise  or  the  competitive  system.  It  is  obviously 
not  at  all  completely  or  perfectly  competitive,  but  just  as 
indisputably  its  general  principles  are  those  of  free  com- 
petition.  Under  these  circumstances  the  study,  as  a  first 
approximation,  of  a  perfectly  competitive  system,  in  which 
the  multitudinous  degrees  and  kinds  of  divergences  are 
eliminated  by  abstraction,  is  clearly  indicated.  The  method 
is  particularly  indicated  in  a  practical  sense  because  our 
most  important  questions  of  social  policy  hinge  directly 
upon  the  question  of  the  character  of  the  "natural"  results 
of  competition,  and  take  the  form  of  queries  as  to  whether 
the  tendencies  of  competition  are  to  be  furthered  and  sup- 
plemented or  obstructed  and  replaced. 

That  such  a  theoretical  first  approximation  is  indicated 
in  a  theoretical  sense,  that  it  is  the  natural  logical  way  of 
going  at  the  problem,  conforming  to  the  workings  of  our 
thought  processes,  is  sufficiently  evidenced  by  the  fact  that 


10  RISK,  UNCERTAINTY,  AND  PROFIT 

this  is  what  economists  have  always  in  fact  done,  ever  since 
there  has  been  such  a  science  or  such  a  social  system  to 

^'be  studied.  They  have,  to  be  sure,  been  criticized  for  do- 
ing it,  and  severely.  But  in  the  present  writer's  judgment 

» f\  theorists  of  the  past  and  present  are  to  be  justly  criti- 
cized not  for  following  the  theoretical  method  and  studying 
a  simplified  and  idealized  form  of  competitive  organi- 
zation, but  for  not  following  it  in  a  sufficiently  self- 
conscious,  critical,  and  explicit  way.  In  their  discussions 
of  methodology  the  historic  economists  have,  indeed,  been 
as  clear  and  explicit  as  could  be  desired,1  but  in  the  use 
of  the  method  as  much  cannot,  unfortunately,  be  said. 

It  should  go  without  saying  that  in  the  use  of  the  scienti- 
fic method  of  reasoning  from  simplified  premises,  it  is  im- 
perative that  it  be  clear  to  the  reasoner  and  be  made  un- 
mistakable to  those  who  use  his  work  what  his  procedure 
is  and  what  presuppositions  are  involved.  Two  supreme 
difficulties  have  underlain  controversies  regarding  method 
in  the  past.  The  first  is  the  strong  aversion  of  the  masses 
of  humanity,  including  even  a  large  proportion  of  "  schol- 
ars, "  to  all  thinking  in  general  terms.  The  second  difficulty, 
on  the  other  side,  is  the  fact  referred  to  above,  that  the 
persons  employing  methods  of  approximation  in  econom- 
ics have  not  themselves  adequately  and  always  recognized, 
and  still  less  have  they  made  clear  to  their  readers,  the 
approximate  character  of  their  conclusions,  as  descriptions 
of  tendency  only,  but  have  frequently  hastened  to  base 
principles  of  social  and  business  policy  upon  very  incom- 
plete data.  The  evil  results  of  the  failure  to  emphasize  the 
theoretical  character  of  economic  speculation  are  apparent 

1  Cf.  Mill's  Essays  on  Unsettled  Questions,  no.  5,  which  really  leaves 
little  to  be  said  on  the  subject.  Also  Cairnes,  on  the  Character  and  Logical 
Method  of  Political  Economy,  and  the  discussions  of  methodology  of  the 
English  economists  generally.  The  conception  of  the  "economic  man" 
was  one  way  of  emphasizing  the  abstract  and  simplified  character  of  the 
premises  of  the  science.  Keynes's  Scope  and  Logical  Method  of  Political 
Economy  is  an  admirably  clear  and  conclusive  discussion  of  this  whole 
subject. 


IN  ECONOMIC  THEORY  11 

in  every  field  of  practical  economics.  The  theorist  not 
having  definite  assumptions  clearly  in  mind  in  working 
out  the  "principles,"  it  is  but  natural  that  he,  and  still 
more  the  practical  workers  building  upon  his  foundations, 
should  forget  that  unreal  assumptions  were  made,  and 
should  take  the  principles  over  bodily,  apply  them  to  con- 
crete cases,  and  draw  sweeping  and  wholly  unwarranted 
conclusions  from  them.  The  clearly  untenable  and  often 
vicious  character  of  such  deductions  naturally  works  to 
discredit  theory  itself.  This,  of  course,  is  wrong;  we  do  not 
allow  perpetual  motion  schemes  to  discredit  theoretical 
mechanics,  which  is  built  upon  the  assumption  of  perpetual 
motion  at  every  stage.  But  in  economics  a  distrust  of 
general  principles,  fatal  as  it  is  to  clear  thinking,  will  be  in- 
evitable as  long  as  the  postulates  of  theory  are  so  nebulous 
and  shifting.  They  can  hardly  be  made  sufficiently  explicit; 
it  is  imperative  that  the  contrast  between  these  simplified 
assumptions  and  the  complex  facts  of  life  be  made  as  con- 
spicuous and  as  familiar  as  has  been  done  in  mechanics. 

The  present  essay  is  an  attempt  in  the  direction  in- 
dicated above. cWe  shall  endeavor  to  search  out  and  plac- 
ard the  unrealities  of  the  postulates  of  theoretical  econom-  * 
ics,  not  for  the  purpose  of  discrediting  the  doctrine,  but 
with  a  view  to  making  clear  its  theoretical  limitations.J 
There  are  several  reasons  why  the  approximate  character 
of  theoretical  economic  laws  and  their  inapplicability 
without  empirical  correction  to  real  situations  should  be 
especially  emphasized  as  compared,  for  instance,  with 
those  of  mechanics.  The  first  reason  is  historical  and  has 
already  been  indicated.  The  limitations  of  the  results 
have  not  always  been  clear,  and  theorists  themselves  as 
well  as  writers  in  practical  economics  and  statecraft  have 
carelessly  used  them  without  regard  for  the  corrections 
necessary  to  make  them  fit  concrete  facts.  Policies  must 
fail,  and  fail  disastrously,  which  are  based  on  perpetual 
motion  reasoning  without  the  recognition  that  it  is  such. 


12  RISK,  UNCERTAINTY,  AND  PROFIT 

In  the  second  place,  the  allowances  and  corrections 
necessary  in  the  case  of  theoretical  economics  are  vastly 
greater  than  in  the  case  of  mechanics,  and  the  importance 
of  not  losing  sight  of  them  is  correspondingly  accentuated. 
The  general  principles  do  not  bring  us  so  close  to  reality; 
there  is  a  larger  proportion  of  factors  in  an  economic  situa- 
tion which  are  of  the  variable  and  fluctuating  sort. 

Again,  in  spite  of  the  greater  contrast  between  theory 
and  practice  in  the  study  of  the  mechanics  of  competition, 
as  compared  with  the  mechanics  of  matter  and  motion, 
the  contrast  is  less  familiar  and  more  easily  overlooked. 
Our  race  has  been  observing  and  handling  in  a  rude  way 
the  latter  type  of  phenomena  ever  since  it  has  lived  on  the 
earth,  while  competitive  relations  among  men  were  es- 
tablished only  a  few  generations  ago.  In  consequence  the 
habit  of  clear  thinking  according  to  scientific  method,  the 
vjuse  of  hypotheses  and  separation  of  fundamental  princi- 
ples from  the  accidents  of  particular  instances,  has  become 
in  some  measure  built  up  in  the  minds  of  at  least  a  respect- 
able body  of  the  more  cultivated  division  of  the  race.  Per- 
haps it  is  even  in  some  degree  instinctive  in  certain  strains.1 

Finally,  it  makes  vastly  more  difference  practically 
whether  we  disseminate  correct  ideas  among  the  people  at 
large  in  the  field  of  human  relations  than  is  the  case  with 

1  It  is  necessary  to  admit  that  in  fact  only  a  pitifully  small  fraction  of 
the  race  have  any  particular  theoretical  sense  in  the  mechanical  field 
either.  Certainly  a  vast  majority  of  literate  adults  with  elementary  ex- 
perience with  machinery  have  no  real  comprehension  of  the  most  funda- 
mental principles  of  the  transformation  and  equivalence  of  forces.  As 
far  as  their  own  insight  is  concerned,  they  could  easily  be  taken  in  with 
crude  perpetual  motion  schemes,  and  an  astonishing  proportion  are  will- 
ing to  back  their  own  judgment  in  such  matters  against  what  they  know 
to  be  the  unanimous  verdict  of  the  scientific  world.  The  recurrent  dis- 
cussion of  such  projects  in  our  National  Congress  are  familiar.  A  certain 
mechanical  "handiness"  is  probably  all  that  is  to  be  found  in  any  but  the 
rare  scientific  minds,  and  these  handy  men  are  precisely  the  ones  who 
seem  most  likely  to  waste  their  lives  and  means  over  palpably  absurd 
enterprises.  A  large  proportion  even  of  competent  engineers  have  neither 
comprehension  nor  appreciation  of  physical  theory. 


IN  ECONOMIC  THEORY  18 

mechanical  problems.  For  good  or  ill,  we  are  committed  . 
to  the  policy  of  democratic  control  in  the  former  case,  and 
are  n#t  likely  to  resort  to  it  in  the  latter.  As  far  as  material 
results  are  concerned,  it  is  relatively  unimportant  whether 
people  generally  believe  in  their  hearts  that  energy  can  be 
manufactured  or  that  a  cannon  ball  will  sink  part  of  the 
way  to  the  bottom  of  the  ocean  and  remain  suspended,  or 
any  other  fundamental  misconception.  We  have  here  at 
least  established  the  tradition  that  knowledge  and  train- 
ing count  and  have  persuaded  the  ignorant  to  defer  to  the 
judgment  of  the  informed.  In  the  field  of  natural  science 
the  masses  can  and  will  gladly  take  and  use  and  construct 
appliances  in  regard  to  whose  scientific  basis  they  are  as 
ignorant  as  they  are  indifferent.  It  is  usually  possible  to 
demonstrate  such  things  on  a  moderate  scale,  and  literally 
to  knock  men  down  with  "results."  In  the  field  of  social 
science,  however,  fortunately  or  unfortunately,  these  things 
are  not  true.  Our  whole  established  tradition  tends  to  the 
view  that  "Tom,  Dick,  and  Harry"  know  as  much  about 
it  as  any  "highbrow";  the  ignorant  will  not  in  general  de- 
fer toT;he  opinion  of  the  informed,  and  in  the  absence  of 
voluntary  deference  it  is  usually  impossible  to  give  an 
objective  demonstration.  If  our  social  science  is  to  yield 
fruits  in  an  improved  quality  of  human  life,  it  must  for  the 
most  part  be  "sold"  to  the  masses  first.  The  necessity  of 
making  its  literature  not  merely  accurate  and  convincing, 
but  as  nearly  "fool-proof"  as  possible,  is  therefore  mani- 
fest. 

Whether  or  not  the  use  of  the  method  of  exact  science  is 
as  necessary  in  the  field  of  social  phenonena  as  the  present 
writer  believes,  it  will  doubtless  be  conceded,  even  by  op- 
ponents of  this  view,  that  it  has  been  employed  in  the  great 
mass  of  the  literature  since  the  modern  science  of  economics 
was  founded.  It  may  also  be  granted  that  the  terminology, 
concepts,  and  modes  of  thinking  in  our  economic  instruc- 
tion and  in  general  discussion  are  and  for  a  long  time  must 


14  RISK,  UNCERTAINTY,  AND  PROFIT 

be  largely  dominated  by  the  established  tradition.  And  it 
will  certainly  not  be  denied  that  if  the  method  of  reason- 
ing from  hypothetical  or  simplified  premises  is  followed, 
its  use  must  be  thoroughly  safeguarded  by  emphasizing  the 
character  of  the  premises  and  the  consequent  conditional 
or  approximate  validity  of  the  conclusions  reached.  If, 
finally,  it  is  admitted  that  this  has  not  been  adequately 
done  hitherto,  and  that  mischief  and  misunderstanding 
have  followed  from  the  loose  use  of  assumptions  and  looser 
application  of  conclusions,  then  the  call  for  such  a  study  as 
the  present  will  be  established. 

The  tendency  toward  a  sharper  separation  of  the  theo- 
retical portion  of  economics  from  the  empirical  portion, 
and  toward  the  clearer  formulation  of  premises,  can  be 
traced  in  the  literature  of  the  subject,  and  notable  progress 
in  the  right  direction  has  recently  been  made.  The  work  of 
the  mathematical  economists  and  non-mathematical  pure 
theorists  has  already  been  mentioned.  A  considerable  and 
fairly  satisfactory  body  of  consciously  and  rigidly  "theoret- 
ical" (i.e.,  general  and  approximate)  doctrine  has  been 
built  up.  The  work  of  Pareto  and  Wicksteed  seems  to  the 
writer  especially  worthy  of  note.  Unfortunately  it  has  not 
achieved  the  recognition  and  been  accorded  the  funda- 
mental place  in  the  general  program  of  the  science  which 
we  think  it  should  have;  mathematical  economics  in  par- 
ticular seems  likely  to  remain  little  more  than  a  cult,  a 
closed  book  to  all  except  a  few  of  the  "initiated."  In  the 
great  mass  of  economic  literature  there  is  certainly  still 
wanting  the  evidence  of  a  comprehensive  grasp  of  general 
principles  and  even  more  of  the  meaning  and  importance 
of  general  principles  in  a  scientific  program.  There  is  still 
a  need  for  thoroughgoing  and  critical  comparison  and  con- 
trast of  theoretical  assumptions  with  the  conditions  of  real 
life  and  of  theoretical  conclusions  with  concrete  facts. 
The  makers  and  users  of  economic  analysis  have  in  general 
still  to  be  made  to  see  that  deductions  from  theory  are 


IN  ECONOMIC  THEORY  15 

necessary,  not  because  literally  true  —  that  in  the  strict 
sense  they  are  useful  because  not  literally  true  —  but  only 
if  they  bear  a  certain  relation  to  literal  truth  and  if  all  who 
work  with  them  constantly  bear  in  mind  what  that  relation 
is.  It  must  be  admitted  that  even  the  pure  theorists  have 
not  generally  been  assiduous  in  emphasizing  the  practical 
significance  of  their  work  and  its  relation  to  the  outside 
body  of  the  science;  they  have  been  too  exclusively  inter- 
ested in  the  construction  of  their  a  priori  systems,  and  per- 
haps a  little  disposed  to  regard  these  as  a  disproportionate 
part  of  economic  science.  Such  a  bias  is  natural  and  even 
useful,  but  in  a  field  where  the  relations  between  theory 
and  practice  do  not  come  instinctively  to  the  minds  of  the 
users  of  both,  the  supplementation  of  theory  by  works  of 
interpretation  becomes  indispensable. 

Indication  of  progress  in  this  field  is  furnished  especially 
by  the  discussion  centering  around  the  concept  of  normal- 
ity in  the  work  of  Marshall  in  England  and  the  related 
notion  of  the  static  state  espoused  in  particular  in  this 
country  by  J.  B.  Clark.1  The  meaning  and  bearings  of  the 
fundamental  concepts  are  in  the  writer's  opinion  much 
better  worked  out  by  Marshall  than  by  any  other* writer 
generally  read.  But  Marshall  himself  has  adopted  a 
cautious,  almost  anti-theoretical  attitude  toward  funda- 
mentals; he  refuses  to  lay  down  and  follow  rigidly  defined 
hypotheses,  but  insists  on  sticking  as  closely  as  possible 
to  concrete  reality  and  discussing  "representative"  con- 
ditions as  opposed  to  limiting  tendencies.  The  gain  in  con- 
creteness  and  realism  is  in  our  opinion  much  more  than 
offset  by  the  obscurity,  vagueness,  and  unsystematic 
character  of  the  discussion,  the  inevitable  consequence  of 
burying  fundamentals  in  an  overwhelming  mass  of  quali- 
fication and  detail.  Professor  Clark,  on  the  other  hand,  is 
frankly  theoretical  and  insistent  upon  the  deliberate  use  of 

1  The  static  state  idea  is  further  developed  along  rigidly  theoretical 
lines  by  Professor  Schumpeter  in  Austria. 


16  RISK,  UNCERTAINTY,  AND  PROFIT 

abstraction.  But  the  writer  at  least  is  unable  to  agree  with 
him  on  the  question  of  what  abstractions  should  be  made 
and  the  manner  of  their  use.  While  the  specifications  for  his 
theoretical  state  are  more  definite  and  explicit  than  those 
of  Marshall,  they  seem  to  us  less  correctly  drawn  up.1 
y  The  opposition  to  pure  theory  in  general  is  based  on  a 
failure  to  understand  it,  and  especially  common  is  the  mis- 
conception as  to  the  meaning  of  static  or  normal  hypothe- 
ses. It  is  not  recognized  that  their  use  is  inherent  in  the 
methodology  of  science,  is  in  fact  the  very  essence  of 
scientific  procedure;  that  it  is  not  at  all  recondite  or  in- 
tellectual in  its  appeal,  but  is  mere  practical  common 
sense.  The  aim  of  science  is  to  predict  the  future  for  the 
purpose  of  making  our  conduct  intelligent.2  Intelligence 
predicts,  as  shown  above,  through  analysis,  by  isolating 
the  different  forces  or  tendencies  in  a  situation  and  study- 
ing the  character  and  effects  of  each  separately.  Static 
method  and  reasoning  are  therefore  coextensive.CPFe  have 
^  no  way  of  discussing  a  force  or  change  except  to  describe  its 
effects  or  results  under  given  conditions.  1 

The  "static"  method  in  economics  does  merely  this. 

f      It  inquires  what  conditions  exist  and  studies  the  results 

•     which  recognizable  forces  at  work  (or  changes  in  progress — 

f\   we  know  nothing  about  force ;  it  is  the  assumed  "  cause  "  of 

change,  which  is  the  only  fact)  tend  to  produce  under  those 

conditions.  It  is  "unreal"  only  in  the  simplification  of  its 

problem;  i.e.,  in  taking  the  more  conspicuous  forces  and 

more  important  conditions  and  provisionally  neglecting 

others.  This  the  limitations  of  our  minds  compel  us  to  do, 

We  must  first  discuss  one  change  at  a  time,  assuming  the 

.  others  suspended  while  that  one  is  working  itself  out  to  its 

final  results,  and  then  attempt  to  combine  the  tendencies  at 

1  We  shall  attempt  to  show  that  it  does  not  represent,  as  Professor 
Clark  contends,  the  assumptions  implicit  in  the  classical  economic  theory. 
(See  chapter  n.) 

2  Cf.  Dewey's  definition  of  reason  as  the  method  of  social  diagnosis 
and  prognosis. 


IN  ECONOMIC  THEORY  17 

work,  estimate  their  relative  importance,  and  make  actual 
predictions.  This  is  the  way  our  minds  work;  we  must 
divide  to  conquer.  Where  a  complex  situation  can  be 
dealt  with  as  a  whole  —  if  that  ever  happens  —  there  is  no 
occasion  for  "thought."  Thought  in  the  scientific  sense, 
and  analysis,  are  the  same  thing. 

cThe  reference  to  final  results  calls  for  a  further  word. 
The  concept  of  equilibrium  is  closely  related  to  that  of 
static  method.  It  is  the  nature  of  every  change  in  the 
universe  known  to  science  to  have  " final' '  results  under 
any  given  conditions,  and  the  description  of  the  change  is 
incomplete  if  it  stops  short  of  the  statement  of  these  ul- 
timate tendencies.  Every  movement  in  the  world  is  and 
can  be  clearly  seen  to  be  a  progress  toward  an  equilib- 
rium."3  Water  seeks  its  level,  air  moves  toward  an  equality 
of  pressure,  electricity  toward  a  uniform  potential,  radia- 
tion toward  a  uniform  temperature,  etc.  CE  very  change  is  an 
equalization  of  the  forces  which  produce  that  change,  and 
tends  to  bring  about  a  condition  in  which  the  change  will 
no  longer  take  place?  The  water  continues  to  flow,  the 
wind  to  blow,  etc.,  only  because  the  sun's  heat  —  itself  a 
similar  but  more  long-drawn-out  redistribution  of  energy 
—  constantly  restores  the  inequalities  which  these  move- 
ments themselves  constantly  destroy. 

r^So  also  in  economic  phenomena.  Goods  move  from  the 
point  of  lower  to  one  of  higher  demand  or  price,  and  every 
such  movement  obliterates  the  price  difference  which 
causes  it.  The  circulation  of  goods  continues  because  the 
life  activities  of  man  (the  production  of  wealth)  keep  new 
supplies  forthcoming.  The  same  applies  to  shifts  in  pro- 
ductive energy  from  one  use  to  another.  There  are  really 
as  many  static  states  as  there  are  changes  to  be  studied,  / 
sets  of  given  conditions  to  be  asumed.  It  is  arbitrary  but1 
convenient  to  speak  of  the  static  state  in  relation  to  given 
conditions  of  the  supply  and  demand  (production  and 
consumption)  of  consumption  goods.    We  shall  see  that 


<^ 


18  RISK,  UNCERTAINTY,  AND  PROFIT 

there  are  in  fact  two  other  fundamental  static  problems;  the 
first  assumes  given  supplies  of  consumption  goods,  and  the 
second,  given  general  conditions  under  which  the  creation 
of  production  goods  and  changes  in  wants  take  place;  the 
first  is  the  problem  of  the  market  or  of  market  price,  and 
the  second  that  of  social  economic  progress,  often  referred 

tjj    to  as  economic  dynamics.  1 

.>■*■"'  c_The  argument  of  the  present  essay  will  center  around 
the  general  idea  of  normality,  viewed  as  an  attempt  to 
isolate  for  study  the  essentials  or  general  principles  of  a 
competitive  social  economic  organization.  The  aim  will  be 
to  bring  out  the  content  of  the  assumptions  or  hypotheses 
of  the  historic  body  of  economic  thought,  referred  to  by 
the  classical  writers  as  "natural  price"  theory.  By  this  is 
meant,  not  the  assumptions  definitely  in  the  minds  of  the 
classical  economists,  but  the  assumptions  necessary  to 
define  the  conditions  of  perfect  competition,  at  which  the 
classical  thought  was  aimed,  and  which  are  significant  as 
forming  the  limiting  tendency  of  actual  economic  proc- 
esses. *3 

As  the  title  of  the  essay  indicates,  our  task  will  be  en- 
visaged from  the  immediate  standpoint  of  the  problem  of 
profit  in  distributive  theory.  C-The  primary  attribute  of 
competition,  universally  recognized  and  evident  at  a 
glance,  is  the  "tendency"  to  eliminate  profit 2  or  loss,  and 
bring  the  value  of  economic  goods  to  equality  with  their 
!  cost. J(Dr,  since  costs  are  in  the  large  identical  with  the 

1  We  need  not  here  more  than  mention  the  obvious  fact  that  the 
theoretical  method  is  applicable  to  monopoly  as  well  as  competition 
and  has  dealt  with  both.  It  has  been,  of  course,  a  theoretically  "ideal" 
monopoly  also  —  the  real  assumption  being  an  exceptional  instance  of 
perfect  monopoly  in  a  general  system  of  perfect  competition.  The  con- 
trast between  theory  and  reality  and  the  significance  of  the  former  is  of 
the  same  sort  in  both  cases,  and  we  shall  also  discuss  the  meaning  of  per- 
fect monopoly  in  the  proper  connection.  (Chapter  vi.) 

2  It  will  be  perceived  that  the  word  "profit"  is  here  used  in  the  sense 
of  "pure  profit,"  a  distributive  share  different  from  the  returns  to  the 
productive  services  of  land,  labor,  and  capital. 


IN  ECONOMIC  THEORY  19 

distributive  shares  other  than  profit,  we  may  express  the 
same  principle  by  saying  that  the  tendency  is  toward  a 
remainderless  distribution  of  products  among  the  agencies 
contributing  to  their  production.  But  in  actual  society, 
cost  and  value  only  "tend"  to  equality;  it  is  only  by  an 
occasional  accident  that  they  are  precisely  equal  in  fact; 
they  are  usually  separated  by  a  margin  of  "profit,"  posi- 
tive or  negative.  Hence  the  problem  of  profit  is  one  way  of 
looking  at  the  problem  of  the  contrast  between  perfect 
competition  and  actual  competition.  J 

Our  preliminary  examination  of  the  problem  of  profit 
will  show,  however,  that  the  difficulties  in  this  field  have 
arisen  from  a  confusion  of  ideas  which  goes  deep  down  into 
the  foundations  of  our  thinking.  The  key  to  the  whole 
tangle  will  be  found  to  lie  in  the  notion  of  risk  or  uncer- 
tainty and  the  ambiguities  concealed  therein.  It  is  around 
this  idea,  therefore,  that  our  main  argument  will  finally 
center.  A  satisfactory  explanation  of  profit  will  bring  into 
relief  the  nature  of  the  distinction  between  the  perfect 
competition  of  theory  and  the  remote  approach  which  is 
made  to  it  by  the  actual  competition  of,  say,  twentieth- 
century  United  States;  and  the  answer  to  this  twofold 
problem  is  to  be  found  in  a  thorough  examination  and 
criticism  of  the  concept  of  Uncertainty,  and  its  bearings 
upon  economic  processes. 

But  Uncertainty  must  be  taken  in  a  sense  radically 
distinct  from  the  familiar  notion  of  Risk,  from  which  it 
has  never  been  properly  separated.  The  term  "risk,"  as 
loosely  used  in  everyday  speech  and  in  economic  dis- 
cussion, really  covers  two  things  which,  functionally  at 
least,  in  their  causal  relations  to  the  phenomena  of 
economic  organization,  are  categorically  different.  The 
nature  of  this  confusion  will  be  dealt  with  at  length  in 
chapter  vn,  but  the  essence  of  it  may  be  stated  in  a  few 
words  at  this  point.  The  essential  fact  is  that  "risk" 
means  in  some  cases  a  quantity  susceptible  of  measure- 


20  RISK,  UNCERTAINTY,  AND  PROFIT 

ment,  while  at  other  times  it  is  something  distinctly  not  of 
this  character;  and  there  are  far-reaching  and  crucial  differ- 
ences in  the  bearings  of  the  phenomenon  depending  on 
which  of  the  two  is  really  present  and  operating.  There  are 
other  ambiguities  m  the  term  "risk"  as  well,  which  will  be 
pointed  out;  but^this  is  the  most  important.  It  will  appear 
that  a  measurable  uncertainty,  or  "risk"  proper,  as  we  shall 
use  the  term,  is  so  far  different  from  an  unmeasurable  one 
that  it  is  not  in  effect  an  uncertainty  at  all.  We  shall 
accordingly  restrict  the  term  "uncertainty"  to  cases  of  the 
non-quantitive  type.  It  is  this  "true"  uncertainty,  and 
kpt  risk,  as  has  been  argued,  which  forms  the  basis  of  a 
V  jralid  theory  of  profit  and  accounts  for  the  divergence  be* 
fcween  actual  and  theoretical  competitijon. 

Aya  background  for  the  discussion  of  the  meaning  and 
causal  relations  of  uncertainty,  we  shall  first  make  a  brief 
survey  of  previously  proposed  theories  of  profit.  After  a 
summary  glance  at  the  history  of  the  treatment  of  the  sub- 
ject down  to  recent  decades,  it  will  be  necessary  to  dwell  at 
slightly  greater  length  upon  the  controversy  recently  car- 
ried on  in  connection  with  the  explanation  of  profit  in 
terms  of  risk.  The  crucial  character  of  the  distinction 
between  measurable  risk  and  unmeasurable  uncertainty 
will  become  apparent  in  this  discussion. 

Part  Two  (chapters  m-vi)  will  be  taken  up  with  an  out- 
line study  of  a  theoretical,  perfectly  competitive  society. 
In  the  course  of  the  argument  it  will  become  increasingly 
evident  that  the  prime  essential  to  that  perfect  competition 
which  would  secure  in  fact  those  results  to  which  actual 
competition  only  "tends,"  is  the  absence  of  Uncertainty 
(in  the  true,  unmeasurable  sense).  Other  presuppositions 
are  mostly  included  in  or  subordinate  to  this,  that  men 
,t**^  must  know  what  they  are  doing,  and  not  merely  guess  more 
or  less  accurately.  The  "tendency"  toward  perfect  com- 
petition is  at  once  explained,  since  men  are  creatures  en- 
dowed with  the  capacity  to  learn,  and  tend  to  find  out  the 


IN  ECONOMIC  THEORY  21 

results  of  their  acts,  while  the  cause  of  the  failure  ever  to 
reach  the  goal  is  equally  evident  so  long  as  omniscience 
remains  unattainable.  Now  since  risk,  in  the  ordinary 
sense,  does  not  preclude  perfect  planning  (for  reasc^ 
which  can  easily  be  made  clear),  such  risk  cannot  pre- 
vent the  complete  realization  of  the  tendencies  of  competi- 
tive forces,  or  give  rise  to  profit. 

At  the  conclusion  of  this  brief  treatment  of  perfect  com- 
petition we  shall  devote  a  short  chapter  to  limitations  of 
perfect  competition  other  than  the  imperfection  of  knowl- 
edge, and  then  take  up  in  Part  Three  a  careful  analysis  of 
the  concepts  of  Risk  and  Uncertainty  (chapter  vu),  pro- 
ceeding (in  the  remaining  chapters)  with  a  somewhat  de- 
tailed study  of  the  effects  of  both,  but  especially  of  true  or 
unmeasurable  uncertainty  upon  the  economic  organization 
and  of  its  bearings  upon  economic  theory.  The  economic 
relations  of  risk  in  the  narrower  sense  of  a  measurable  prob- 
ability have  been  extensively  dealt  with  in  the  literature  of 
the  subject  and  do  not  call  for  elaborate  treatment  here. 
Our  main  concern  will  be  with  the  contrast  between  Risk 
as  a  known  chance  and  true  Uncertainty,  and  treatment 
of  the  former  is  incidental  to  this  purpose. 


CHAPTER  II 

THEORIES  OF  PROFIT;  *  CHANGE  AND  RISK  IN 
RELATION  TO  PROFIT 

In  view  of  the  facts  set  forth  in  the  introductory  chapter 
as  to  the  relation  of  profit  to  theoretical  economics,  and  the 
vagueness  in  the  minds  of  economic  writers  as  to  funda- 
mental postulates,  it  is  not  surprising  that  the  theory  of 
profit  has  remained  one  of  the  most  unsatisfactory  and 
controversial  divisions  of  economic  doctrine.  Considering, 
however,  the  universal  recognition  of  the  "  tendency "  of 
competition  to  eliminate  profit,  it  is  perhaps  somewhat  re- 
markable that  the  problem  of  profit  itself  has  not,  with  one 
important  exception,2  been  attacked  from  the  direct  point 
of  view  adopted  in  this  essay,  of  an  inquiry  into  the  causes 
of  the  failure  of  ideal  competition  to  be  fully  realized  in  fact. 
It  is,  indeed,  only  within  comparatively  recent  years  that 
the  existence  of  profit  as  a  really  distinct  share  has  become 
established  and  the  problem  of  its  explanation  given  de- 
finite status. 

As  in  the  case  of  most  sciences  whose  subject  matter  is 
some  field  of  human  activity,  economic  theory  has  been 
much  influenced  by  practice,  and  in  particular  the  loose  use 

1  Excellent  histories  of  profit  theory  are  to  be  found  in  the  introduc- 
tory sections  of  several  monographs  on  profit  and  make  it  superfluous  to 
go  into  this  phase  of  the  subject  in  detail.  See  especially  the  following: 

Mangoldt,  H.  v.,  Die  Lehre  vom  Unternehmergewinn.   Leipsic,  1855. 
Pierstorff,  J.,  Die  Lehre  vom  Unternehmergewinn.   Berlin,  1875. 
Mataja,  V.,  Der  Unternehmergewinn.  Vienna,  1884. 
Gross,  G.,  Die  Lehre  vom  Unternehmergewinn.  Leipsic,  1884. 
Porte,  M.,  Entrepreneurs  et  'profits  industriels.  Paris,  1901. 

2  The  exception  is  Professor  Clark's  theory  of  perfect  competition  as 
equivalent  to  the  "static  state"  and  the  corresponding  "dynamic 
theory  "  of  profit  as  the  result  of  progress.  This  view  will  presently  be 
taken  up  and  criticized. 


THEORIES  OF  PROFIT  23 

of  terms  in  everyday  affairs  has  given  rise  to  serious  con- 
fusions in  terminology.  The  concept  of  profit  is  bound  up 
in  a  certain  type  of  organization  of  industry,  a  type  realized 
in  various  degrees  in  different  places  and  times,  and  always 
undergoing  modification  and  development. 

At  the  time  when  the  English  classical  school  of  eco- 
nomists were  writing  —  i.e.,  in  the  later  eighteenth  and 
early  nineteenth  centuries  —  corporations  were  relatively 
unimportant,  being  practically  restricted  to  a  few  banks 
and  trading  companies.  There  was,  of  course,  some  lend- 
ing at  interest,  but  in  the  dominant  form  of  industry  men 
used  their  own  capital,  hiring  labor  and  renting  land  from 
others.  The  managerial  function  centered  in  the  capital- 
ist. Moreover,  English  industries  were  new  and  rapidly 
expanding;  competition  was  not  highly  developed;  the 
possession  of  capital  seemed  to  be  and  was  the  dominant 
factor  in  the  situation.  Only  in  more  recent  times  has  the 
accumulation  of  capital,  the  perfection  of  financial  institu- 
tions, and  the  growth  of  competition  transferred  the  center 
of  interest  to  business  ability,  made  it  easy  or  at  least 
generally  possible  for  ability  to  secure  capital  when  not  in 
possession  of  it  by  direct  ownership,  and  made  common 
the  carrying-on  of  business  predominantly  with  borrowed 
resources. 

Under  these  early  conditions  it  was  natural  to  connect 
the  income  of  the  business  manager  with  the  ownership  of 
capital,  and  in  all  the  classical  writings  we  find  the  word 
"profit"  used  in  this  sense.  A  further  source  of  confusion 
was  the  indefiniteness  of  the  conception  and  use  of  the 
ideas  of  natural  and  market  price  in  the  minds  of  the  early 
writers.  It  is  natural  and  inevitable  that  a  distinction 
which  goes  to  the  heart  of  the  fundamental  problems  of  the 
nature  and  methodology  of  economic  science  should  be 
but  imperfectly  worked  out  in  the  initial  stages  of  the 
speculation.  Only  recently,  again,  has  the  analysis  of 
long-time  normal  price  by  Marshall  and  of  the  "static 


24  RISK,  UNCERTAINTY,  AND  PROFIT 

state"  by  Clark  and  Schumpeter  begun  to  give  to  econo- 
mists a  clearer  notion  of  what  is  really  involved  in  "natu- 
ral" or  normal  conditions.  To  the  earlier  classical  writers 
this  obscurity  hid  the  fundamental  difference  between  the 
total  income  of  the  capitalist  manager  and  contract  in- 
terest. The  only  separation  considered  necessary  in  the 
explanation  of  distribution  was  to  restrict  the  theory  of  the 
business  manager's  income  to  the  explanation  of  "normal 
profit,"  which  was  regarded  as  substantially  equivalent  to 
contract  interest.  Another  barrier  to  the  formulation  of  a 
clear  statement  of  the  relations  between  interest  and  pro- 
fit was  the  lack  of  an  adequate  understanding  of  the  pro- 
ductivity of  capital,  which  also  these  authors  did  not  pos- 
sess and  which  has  first  been  worked  out  in  recent  years. 
The  qualification  of  "near"  or  "substantial"  identifica- 
tion of  normal  profit  and  interest  is  necessary,  however,  in 
referring  to  the  classical  treatments.  Even  Adam  Smith 
and  his  immediate  followers  recognized  that  profits  even 
normally  contain  an  element  which  is  not  interest  on  capi- 
tal. Remuneration  for  the  work  and  care  of  supervising 
the  business  was  always  distinguished.  Reference  was  also 
made  to  risk,  but  in  the  sense  of  risk  of  loss  of  capital,  which 
does  not  clearly  distinguish  profit  from  interest.1  Adam 
Smith  is  explicit  in  regard  to  these  elements,  while  Malthus 
and  M'Culloch  were  more  so.  J.  S.  Mill  pointed  out  in 
a  somewhat  groping  way  that  the  wages  of  management 
are  determined  in  a  different  way  from  other  wages,  and 

1  For  a  fuller  discussion  of  the  views  of  the  English  writers,  with  cita- 
tions, see  Cannan,  Theories  of  Production  and  Distribution,  chap,  vi, 
sec.  2;  also  the  same  author's  article  on  "Profit"  in  Palgrave's  Dictionary 
of  Political  Economy.  In  opposition  to  the  German  historians  and  critics, 
who  take  the  classical  economists  very  literally,  Cannan  is  sure  that  they 
really  held,  like  their  French  followers,  a  wage  theory  of  profit.  Between 
the  two  views  this  seems  the  fairer  on  the  whole,  but  it  could  hardly  be 
maintained  that  the  difference  in  expression  does  not  represent  some 
difference  in  thought.  However,  much  of  the  contrast  is  undoubtedly 
due  to  differences  in  the  use  of  terms.  Old  words  used  to  designate  new 
things  necessarily  become  ambiguous,  and  "profit"  is  still  correctly  used 
with  several  different  meanings. 


THEORIES  OF  PROFIT  25 

noted  also  that  profits,  so  called,  include  as  a  third  ele- 
ment a  payment  for  risk,  as  well  as  wages  of  management 
(and  interest).  The  inclusion  of  interest  in  profit  was  op- 
posed by  Bagehot,  and  in  the  United  States  by  Walker, 
but  the  use  of  the  term  is  still  somewhat  loose  in  England, 
as  is  seen  in  Marshall.  Even  in  this  country  the  develop- 
ment of  corporation  accounting,  while  separating  wages  of 
management  from  profit,  has  tended  to  a  new  confusion  of 
profit  and  interest. 

The  early  French  writers,  beginning  with  J.  B.  Say, 
adopted  a  different  view  of  profit,  or  at  least  a  different 
use  of  the  word,  insisting  on  a  separation  of  profit  from  in- 
terest and  defining  the  former  explicitly  as  a  wage.  The 
difference  in  procedure  may  have  been  due,  as  v.  Man- 
goldt  suggests,1  to  the  different  character  of  typical  French 
industry  and  the  greater  importance  of  the  manager's 
personality  in  it  relatively  to  the  capital  factor.  It  is 
worthy  of  note  that  in  the  fourth  edition  of  his  "Traite," 
Say  included  in  profit  the  reward  for  risk-taking;  he  had  in 
Hhe  earlier  editions  viewed  this  income  as  accruing  to  the 
capitalist  as  such,  but  now  transferred  it  to  the  entrepre- 
neur. Especial  mention  should  be  made  of  Courcelle-\ 
Seneuil,  who  insisted  that  profit  is  not  a  wage,  but  is  due  to 
the  assumption  of  risk.2 

The  older  German  economists  varied  widely  in  their 

1  Op.  cit.t  p.  19,  note. 

2  Article,  "Profit,"  in  Coquelin  and  Guillaumin's  Dictionnaire  de 
VSconomie  politique,  Paris,  1852.  It  is  true  that  in  another  work  (TraitS 
d'Sconomie  politique,  2d  ed.,  1867)  Courcelle  was  not  so  explicit,  and  also 
that  in  the  same  article  he  says  that  profit  depends  on  the  intelligence  of 
the  entrepreneur  and  the  favorable  or  unfavorable  conditions  under  which 
he  works.  This  hesitation  may  explain  Kleinwachter's  classifying  him 
with  the  followers  of  Say  and  adherents  of  the  wages  theory.  (See  Das 
Einkommen  und  seine  Verteilung,  p.  278.)  It  seems  more  probable,  how- 
ever, that  Courcelle  glimpsed  the  fact  (which  KleinwSchter  did  not)  that 
the  assumption  of  a  "risk"  of  error  in  one's  own  judgment,  inherent  in 
the  making  of  a  responsible  decision,  is  a  phenomenon  of  a  different  char- 
acter from  the  assumption  of  "risk"  in  the  insurance  sense.  We  shall 
build  largely  upon  this  distinction  later. 


26  RISK,  UNCERTAINTY,  AND  PROFIT 

treatment  of  profits.  Some,  of  whom  Schaffle  is  perhaps 
the  most  notable  example,  follow  the  "English"  view  in 
glassing  profit  as  essentially  a  return  to  capital.  Others, 
notably  Roscher,  adopt  the  "French"1  attitude  and  treat 
it  as  a  form  of  wages.  Roscher  does  not  even  use  the  term 
"profit,"  but  substitutes  Unternehmerlohn.  Other  writers, 
such  as  Hermann  and  Rau,  took  a  more  or  less  intermediate 
position. 

Still  another  group,  of  more  importance  for  our  purposes, 
contended  that  profit  should  be  recognized  as  a  unique 
form  of  income,  not  susceptible  of  reduction  to  remunera- 
tion for  either  capital  or  labor.  This  position  was  taken  in  a 
somewhat  timid  way  by  Hufeland 2  and  more  definitely  by 
Riedel, 3  but  its  most  notable  advocates  were  Thiinen  and 
v.  Mangoldt.  Thiinen's  great  work,  "Der  Isolirte  Staat,"  4 
defines  profit  as  what  is  left  after  (a)  interest,  (b)  insurance, 
and  (c)  wages  of  management,  are  met.  This  residuum  con- 
sists of  two  parts:  (1)  payment  for  certain  risks,  especially 
changes  in  values  and  the  chance  of  failure  of  the  whole 
enterprise,  which  cannot  be  insured  against,  and  (2)  the 
extra  productivity  of  the  manager's  labor  due  to  the  fact 
that  he  is  working  for  himself,  his  "sleepless  nights"  when 
he  is  planning  for  the  business.   Thiinen  called  these  ele- 

1  These  national  designations  of  the  two  schools  hold  closely.  The 
only  notable  exceptions  (aside  from  Courcelle)  are  on  the  one  side,  Rossi, 
a  French  (naturalized  Italian)  writer,  who  strongly  espoused  the  capital- 
istic or  English  view,  and  on  the  other  Samuel  Read,  who,  while  agreeing 
with  the  current  English  treatment  in  terminology,  broke  with  it  in  sub- 
stance and  agreed  with  Say  and  his  followers.  Read  insisted  on  identify- 
ing "profit"  with  the  return  to  capital,  or  interest,  and  treating  the  dis- 
tinctive income  of  the  entrepreneur  as  a  wage.  He  also  emphasized  the 
"compensation  for  risk"  element  in  his  "profit"  (really  interest),  but 
thought  it  due  to  no  determinate  causes  and  "outside  the  pale  of  science/* 
This  last  phrase  shows  at  least  an  insight  into  the  unique  character  of 
this  sort  of  risk,  since  the  assertion  would  certainly  not  have  been  made  of 
an  insurance  premium.  See  his  Political  Economy,  Edinburgh,  1829,  pp. 
263  and  269,  note. 

a  Neue  Grundlage  der  Staatsimssenschaft,  vol.  I.  Giessen,  1807. 

3  National  Okonomie,  1839. 

4  Appeared  1826.  3d  ed.,  1876.  See  3d  ed.,  vol.  n,  pp.  83  ff. 


THEORIES  OF  PROFIT  27 

ments  respectively  Industriebelohnung  and  Unternehmer- 
gewinn,  and  their  sum  Gewerbsprqfit. 

A  most  careful  and  exhaustive  analysis  of  profit  is  con- 
tained in  the  monograph  of  H.  v.  Mangoldt,  already  re- 
ferred to.  Proceeding  on  the  basis  of  an  elaborate  classifi- 
cation of  the  forms  of  industrial  organization  and  a  dis- 
cussion of  the  economic  advantages  of  the  entrepreneur 
form,  this  writer  finds  in  the  income  of  the  business  enter- 
priser a  complex  group  of  unique  elements.  He  divides  it 
first  into  three  parts:  (1)  a  premium  on  those  risks  which 
v  are  of  such  a  nature  that  he  cannot  shift  them  by  insurance; 

(2)  entrepreneur  interest  and  wages,  including  only  pay- 
ments for  special  forms  of  capital  or  productive  effort  which 
do  not  admit  of  exploitation  by  any  other  than  their  owner; 

(3)  entrepreneur  rents.  These  last  again  fall  into  four  sub- 
divisions: (a)  capital  rents,  (b)  wage  rents,  (c)  large  enter- 
prise rent,  and  (d)  "entrepreneur  rent  in  the  narrower 
sense."  They  are  all  due  to  the  limitation  of  special  capac- 
ities or  characteristics  (the  last  to  special  combinations  of 
such)  and  are  called  "premiums  on  scarcity"  (Seltenheits- 
prameien).  This  is,  of  course,  a  question-begging  term 
(though  many  writers  have  used  it)  since  all  incomes  de- 
pend in  the  same  way  on  the  limitation  of  the  agencies  to 
which  they  are  imputed.  It  would  seem  that  every  im- 
aginable source  of  income  is  included  in  this  minute  and 
subtle  classification. 

A  special  place  in  the  history  of  theories  of  profit  should 
be  given  to  the  German  socialist  school,  the  so-called 
"scientific"  socialists,  Rodbertus,  Marx,  Engels,  Lassalle, 
and  their  followers.  These  writers  take  the  English  classi- 
cal treatment  of  profit  in  a  narrowly  literal  (one  must  say 
whoUyjmcriticjdjm^  sense  as  including  all  in- 

come accruing  to  capital,  to  which  they  add  land.  Com- 
bining this  with  an  equally  blind  reading  of  the  labor  theory 
pf  value  which  was  the  starting-point  of  Smith  andRicardo, 
they  derive  a  simple  classification  of  income  in  which  all 


28  RISK,  U  TAINTY,  AND  PROFIT 

that  is  not  wages  is  a  profit  which  represents  exploitation 
^jpf  the  working  classes.  Capital  is  equivalent  to  property, 
which  is  to  be  regarded  as  mere  power  over  the  economic 
activities  of  others  due  to  the  strategic  position  of  owner- 
ship over  the  implements  of  labor.  It  is  analogous  to  a 
robber  baron's  crag,  a  toll-gate  on  a  natural  highway,  or  a 
political  franchise  to  exploit.  Pierstorff,  in  the  monograph 
referred  to  above,  follows  Rodbertus  in  the  main,  after 
criticizing  alternative  views.1 

After  the  publication  in  1871  of  Menger's  "Grund- 
satze"  had  given  a  new  interest  and  new  turn  to  value 
theory  in  Austria  and  Germany,  a  notable  series  of  dis- 
cussions of  profit  appeared  in  those  countries.  Those  call- 
ing for  especial  mention  are  the  monographs  of  Gross  2 
and  Mataja 3  and  the  treatments  by  Mithoff  4  and  Klein- 
wachter  6  in  Schonberg's  "Handbuch,"  the  last-named 
elaborated  in  the  author's  book  already  referred  to.  Gross 
takes  as  his  starting-point  the  plain  fact  that  profit  is  the 
difference  between  the  cost  of  goods  and  their  value,  and 
studies  the  position  of  the  entrepreneur  in  the  two  markets 
in  which  he  buys  productive  services  and  raw  materials  and 
sells  his  finished  product.  He  may  be  said  to  reduce  profit 
to  bargaining  power,  in  which,  of  course,  superior  knowl- 
edge and  foresight  are  recognized  as  playing  a  large  part, 

1  See  also  the  article  "  Unternehmergewinn,"  by  Pierstorff  in  Con- 
rad's Handworterbuch  der  Staatswissenschaften.  Dr.  Thorstein  Veblen's 
conceptions  of  capital  and  profit  show  strong  leanings  toward  the  same 
views. 

2  Referred  to  above,  p.  22  n.  8  Ibid. 

4  G.  Schonberg,  Handbuch  der  Politischen  OJconomie,  2d  ed.  (Tubingen, 
1885),  pp.  670  ff. 
6  Ibid.,  pp.  220  ff. 
Other  works  in  the  same  group  with  the  above  are: 

E.  Aug.  Schroeder,  Das  Unternehmen  und  der  Unternehmergewinn. 
Vienna,  1884.  (The  same  date  of  publication  as  Gross  and  Mataja.)/ 
A.  Wirminghaus,  Das  Unternehmergewinn  und  die  Beteiligung 

Arbeiter  am  Unternehmergewinn.  Jena,  1886. 
E.  Zuns,  Swei  Fragen  des  Unternehmer-Einkommens.    Berlin,  1881! 
A.  Korner,  Unternehmen  und  Unternehmergewinn.  Vienna,  1893. 


THEORIES  OF  PROFIT  29 

but  Gross  does  not  work  out  a  systematic  treatment  of  the 
nature  and  significance  of  risk  or  uncertainty.  He  thinks  an 
income  which  is  a  premium  for  taking  risks  is  inherently 
impossible,  as  gains  and  losses  would  necessarily  balance. 
Few  other  writers  agree  with  this  proposition.  Socially, 
profit  is  for  Gross  the  inducement  to  follow  closely  the 
economic  law  of  cheapest  possible  production  and  most 
effective  utilization  of  goods. 

Mataja's  analysis  of  profit  is  a  more  literal  application 
of  Menger's  utility  theory  of  value.  He  seeks  to  explain 
price  differences  by  means  of  the  differences  between  the 
various  uses  of  "goods  of  higher  order' *  in  making  differ- 
ent kinds  of  "goods  of  lower  order"  and  ultimately  different 
consumption  ge*ds.  His  discussion  does  not  get  beyond  a 
statement  of  the  problem. 

Mithoff  holds  that  the  entrepreneur's  income  consists  of 
rents,  wages,  etc.,  at  market  rates  for  the  productive  serv- 
ices which  he  furnishes  to  the  business,  plus  a  "profit" 
which  may  be  regarded  as  remuneration  for  taking  the  risk 
of  its  failure.  He  contends,  however,  that  this  profit  is  at 
best  a  mere  abstraction,  a  complex  of  a  number  of  inde- 
terminate surpluses,  and  that  the  entrepreneur  income  as  a 
whole  alone  has  definite  meaning  or  practical  significance. 

Kbrner  is  another  writer  who  explains  the  entrepreneur's 
income  in  terms  of  superior  bargaining  power.  His  position 
is  figured  as  that  of  a  watchman  on  a  tower  and  is  summed 
up  in  the  expression  that  his  is  a  wider  market  than  that  of 
the  men  he  buys  from  and  sells  to,  especially  the  laborer 
whom  he  hires.  The  essential  mystery  of  why  the  com- 
petition of  other  watchmen  on  similar  towers  does  not 
eliminate  his  peculiar  gain  is  not  touched  upon.  The  non- 
socialistic  German  writers  are  usually  particularly  con- 
cerned to  combat  the  allegations  of  the  socialists  and  fur- 
nish a  social  justification  of  profit. 

Kleinwachter  views  profit  from  the  social  standpoint  as 
pay  for  taking  the  twofold  risk  of  production  —  technical 


30  RISK,  UNCERTAINTY,  AND  PROFIT 

and  economic,  a  distinction  made  by  Gross  —  and  for  the 
care  of  supervision.  From  the  individual  point  of  view  it  is 
a  speculative  gain  arising  from  advantage  taken  of  differ- 
ences between  the  prices  of  economic  goods  and  the  prices 
of  the  agents  necessary  to  their  production.  In  his  fuller 
treatment  in  his  book  on  distribution,  Kleinwachter  de- 
votes most  of  his  energy  to  a  sarcastic  polemic  against  the 
English  classical  economic  theory,  according  to  which  the 
prices  of  commodities  should  equal  their  costs  of  produc- 
tion or  the  sum  of  the  wages,  interest,  and  rent  paid  the 
agents  employed  to  produce  them.  No  serious  criticism  of 
this  theory  is  attempted,  however,  nor  any  sign  displayed 
of  a  comprehension  of  its  real  meaning  as  a  statement  of  the 
limits  of  tendencies.  The  general  conclusion  that  the  exist- 
ence of  profit  follows  from  a  divergence  between  the  con- 
ditions of  theory  and  those  of  fact  is  the  starting-point  of 
the  present  study.  It  is,  of  course,  a  statement  of  the 
problem,  and  not  a  solution  of  it;  Kleinwachter  virtually 
explains  profit  by  ridiculing  the  idea  that  it  should  be 
thought  to  call  for  explanation. 

In  other  than  the  German-speaking  countries  the  sub- 
ject of  profit  has  not  been  prolific  of  independent  mono- 
graphs and  treatises,  but  has  usually  been  dealt  with  as  an 
integral  part  of  the  general  theory  of  distribution  (though 
there  are  some  exceptions  in  France  and  Italy  which  would 
have  to  be  noticed  in  a  fuller  historical  treatment).  It  is,  of 
course,  impossible  to  take  up  even  the  important  theorists 
in  all  countries  and  summarize  their  views,  while  any  brief 
treatment  by  schools  or  groups  would  be  misleading  rather 
than  helpful.  The  writers  already  mentioned  pretty  well 
cover  the  fundamental  theories  and  standpoints,  with  ex- 
ceptions yet  to  be  noted.1  A  very  common  procedure  is  to 
treat  profit  as  a  special  case  of  monopoly  gain,  or  to  com- 

1  A  noteworthy  innovation  in  the  treatment  of  profit  has  been  made 
by  a  recent  French  writer,  M.  B.  Lavergne,  in  his  ThSorie  des  Triarchies 
Sconomiques  (Paris,  1910).  In  his  view  profit  is  the  remuneration  of  the 
idte  productrice,  which  is  elevated  to  the  position  of  an  independent  pro- 


THEORIES  OF  PROFIT  31 

bine  elements  of  monopoly  position  with  other  factors. 
This  method  is  apt  to  degenerate  into  a  mere  confusion  of 
the  two  income  categories.  The  common  use  of  the  term 
■x  "  monopoly  profit "  to  designate  monopoly  revenue  directly 
incites  to  this  confusion. 

The  first  notable  development  in  the  field  of  profit  theory 

*  in  America  was  the  work  of  General  Francis  A.  Walked  * 
Walker  effectually  emphasized  the  place  and  importance  of 
the  entrepreneur  or  "captain  of  industry,"  and  helped  to 
free  economic  treatises  in  English  from  the  careless  han- 
dling of  profit  as  an  element  in  interest.  His  own  "rent 
theory,"  however,  in  spite  of  its  vogue  at  the  time  of  its 
promulgation,  need  not  now  detain  us.  Walker  wrote  be- 
fore Marshall,  Clark,2  and  Hobson 3  had  shown  that  all 

*  incomes  are  like  rent  in  the  mode  of  their  determination, 
and  with  that  point  once  made  clear  the  rent  theory  is 

"  reduced  to  a  wage  theory  merely,  and  its  special  signifi- 
cance disappears. 

More  recently  the  center  of  interest  in  the  discussion  of 
profit  has  shifted  from  Walker's  theory  to  two  other  op- 
posed views,  the  "dynamic  theory"  and  the  "risk  theory  " 
respectively.  The  former  is  the  view  upheld  by  Professor 
J.  B.  Clark  and  his  followers  and  the  latter  is  sponsored  in 
particular  by  Mr.  F.  B.  Hawley.4  Neither  the  connection 

ductive  factor.  His  book  outlines  an  ingenious  and  suggestive  theory  of 
distribution.  See  review  by  Professor  A.  A.  Young,  American  Econoyti 
Review,  vol.  I,  pp.  549  ff.  ^S 

1  Political  Economy,  part  iv,  chap.  iv.  See  also  "The  Source  of  Busi- 
ness Profits  and  Reply  to  Mr.  Mac  vane,"  Quarterly  Journal  of  Economics, 
vol.  i,  pp.  265  ff .,  and  vol.  n,  pp.  263  ff.  (Macvane  held  a  monopoly  theory; 
cf.  Quarterly  Journal  of  Economics,  vol.  n,  pp.  1  ff.  and  453  ff.)  A  view 
similar  to  that  of  Walker  has  been  advocated  in  France  by  Leroy-Beau- 
lieu  (Sr.).  See  Memories  de  V Academic  des  sciences  morales  et  politiques, 
vol.  i,  pp.  717  ff,  and  TraitS  oViconomie  'politique,  part  iv,  chap.  ix. 

2  "  Distribution  as  Determined  by  a  Law  of  Rent,"  Quarterly  Journal 
of  Economics,  vol.  v,  pp.  289  ff. 

8  "The  Law  of  the  Three  Rents,"  ibid.,  vol.  v,  pp.  263  ff. 
More  exhaustive  than  either  Clark  or  Hobson  is  Wicksteed,  The 
Coordination  of  the  Laws  of  Distribution,  London,  1894. 
4  It  is  not  meant  that  these  are  the  only  noteworthy  advocates  of  the 


32  RISK,  UNCERTAINTY,  AND  PROFIT 

between  profit  and  changes  in  conditions  nor  that  between 
profit  and  risk  is  an  entirely  new  idea,  but  hitherto  neither 
had  been  erected  into  a  definite  and  ostensibly  sufficient 
principle  of  explanation  of  the  peculiar  income  of  the  en- 
trepreneur. These  two  theories  call  for  somewhat  fuller 
treatment. 

The  dynamic  theory  is  a  correlate  of  Professor  J.  B. 
Clark's  theory  of  distribution  in  the  profitless  "static 
state."1  Professor  Clark  outlines  a  systematic  structure  of 
theoretical  economics  in  three  main  divisions. 

The  first  treats  of  universal  phenomena,  and  the  second  of 
static  social  phenomena.  Starting  with  those  laws  of  economics 
which  act  whether  humanity  is  organized  or  not,  we  next  study 
the  forces  that  depend  on  organization  but  do  not  depend  on 
progress.  Finally  it  is  necessary  to  study  the  forces  of  progress. 
To  influences  that  would  act  if  society  were  in  a  stationary  state, 
we  must  add  those  which  act  only  as  society  is  thrown  into  a 
condition  of  movement  and  disturbance.  This  will  give  us  a 
science  of  Social  Economic  Dynamics.2 

The  static  state  is  the  state  of  "natural"  adjustments  of 
Ricardo  and  the  early  classical  writers. 

What  are  called  "natural"  standards  of  values  and  "natural" 
or  normal  rates  of  wages,  interest,  and  profits  are  in  reality,  static 
rates.  They  are  identical  with  those  which  would  be  realized,  if 

views  in  question,  nor  that  other  American  writers  on  distribution  have 
not  been  in  some  degree  original  in  their  treatment  of  profit.  The  dis- 
cussions by  the  various  authors  —  Davenport,  Ely,  Fetter,  Fisher, 
Johnson,  Seager,  Seligman,  Taussig,  and  others  —  are  accessible  every- 
where. Perhaps  especial  mention  should  be  made  of  the  chapter  on  profit 
in  Carver's  Distribution  of  Wealth.  Carver's  distinction  between  com- 
pensation for  risk-taking  and  the  results  of  successful  risk-taking  points 
to  the  direction  in  which  a  solution  of  the  problem  is  to  be  sought.  Other 
writers  also  have  seen  the  importance  of  a  critical  dissection  of  the  risk 
concept,  but  none  have  so  far  carried  out  the  work.  Unquestionably  the 
best  of  these  textbook  discussions  is  that  of  Professor  F.  M.  Taylor  in 
his  unpublished  Principles  of  Economics,  a  work  characterized  through- 
out by  correctly  reasoned  and  accurately  stated  theoretical  argument. 

1  See  The  Distribution  of  Wealth,  1900;  and  Essentials  of  Economic 
Theory,  1907. 

2  The  Distribution  of  Wealth,  pp.  30,  31. 


THEORIES  OF  PROFIT  33 

a  society  were  perfectly  organized,  but  were  free  from  the  dis- 
turbances that  progress  causes.  .  .  .  Reduce  society  to  a  station- 
ary state,  let  industry  go  on  with  entire  freedom,  make  labor 
and  capital  absolutely  mobile  . . .  and  you  will  have  a  regime  of 
natural  values.1 

To  realize  the  static  state,  we  should  have  to  eliminate 
five  kinds  of  change  which  are  constantly  in  progress : 

Five  generic  changes  are  going  on,  every  one  of  which  reacts 
on  the  structure  of  society,  by  changing  the  arrangements  of  that 
group  system  which  it  is  the  work  of  catallactics  to  study:  nf  Ji 

1.  Population  is  increasing.  u^ 

%  Capital  is  increasing. 

3.  Methods  of  production  are  improving.  -ft* 

4.  The  forms  of  industrial  establishments  are  changing,  the 
less  efficient  shops,  etc.,  are  passing  from  the  field,  and  the, 
more  efficient  are  surviving.  .  I    p/*  ' 

5.  The  wants  of  consumers  are  multiplying.2  \£    T* 

In  the  static  state  each  factor  secures  what  it  produces,^ 
and  since  cost  and  selling  price  are  always  equal  there  can 
be  no  profits  beyond  wages  for  the  routine  work  of  super- 
vision. 

The  prices  of  goods  are  in  these  older  theories  said  to  be 
"natural"  when  they  equal  the  cost  of  producing  them; ...  in 
reality  their  "natural  prices"  were  static  prices.3 

The  prices  that  conform  to  the  cost  of  production  are,  of  course, 
those  which  give  no  clear  profit  to  the  entrepreneur.  A  business 
man  whose  goods  sell  at  such  rates  will  get  wages  for  whatever 
amount  of  labor  he  may  perform,  and  interest  for  any  capital 
that  he  may  furnish;  but  he  will  have  nothing  more  to  show  in  the 
way  of  gain.  He  will  sell  his  product  for  what  the  elements  that 
compose  it  have  really  cost  him,  if  his  own  labor  and  the  use  of 
his  capital  be  counted  among  the  costs.  We  shall  see  that  this 
condition  of  no-profit  prices  exactly  corresponds  to  the  one  that 
would  result  from  the  static  adjustment  of  the  producing  groups.4 

1  The  Distribution  of  Wealth,  p.  29. 

2  Ibid.,  p.  56.  s  Ibid.,  pp.  68-69. 

4  Ibid.  Professor  Joseph  Schumpeter,  who  has  carried  the  static 
analysis  farther  in  some  respects  than  Professor  Clark,  points  out  that  in 


34  BISK,  UNCERTAINTY,  AND  PROFIT 

V  Profits  are,  then,  the  result  exclusively  of  dynamic 
change.  "Obviously,  from  all  these  changes  two  general 
results  must  follow:  first,  values,  wages  and  interest  will 
differ  from  the  static  standards;  secondly,  the  static  stand- 
ards themselves  will  always  be  changing."  1  The  type  of 
dynamic  change  is  invention;  "an  invention  makes  it 
possible  to  produce  something  more  cheaply.  It  first  gives 
a  profit  to  entrepreneurs  and  then  .  .  .  adds  something  to 
wages  and  interest.  .  .  .  Let  another  invention  be  made. 
...  It  also  creates  a  profit;  and  this  profit,  like  the  first,  is 
an  elusive  sum,  which  entrepreneurs  grasp  but  cannot 
hold."  It  "slips  through  their  fingers  and  bestows  itself  on 
all  members  of  society." 2  Thus  the  effect  of  any  one 
dynamic  change  is  to  produce  temporary  profits.  But  in 
actual  society  such  changes  constantly  occur,  and  the  re- 
adjustments are  always  in  process.  "As  a  result,  we  .  .  . 
have  the  standard  of  wages  moving  continuously  upward 
and  actual  wages  steadily  pursuing  the  standard  rate  in  its 
upward  movement,  but  always  remaining  by  a  certain  in- 
terval behind  it."  3 

In  another  sense  profit  is  dependent  on  "friction": 
"The  interval  between  actual  wages  and  the  static  stand- 
ard is  the  result  of  friction;  for,  if  competition  worked  with- 
out let  or  hindrance,  pure  business  profit  would  be  an- 
nihilated as  fast  as  it  could  be  created.  .  .  ."  4  "Were  it  not 
for  that  interval,  entrepreneurs  as  such  would  get  nothing, 

the  static  state  there  is  no  entrepreneur,  properly  speaking.  The  con- 
sumer, he  adds,  is  really  the  entrepreneur;  but  it  would  seem  preferable 
to  say  that  the  function  is  absent  and  let  it  go  at  that.  (Theorie  der 
Wirtschaftliche  Entwickelung.)  /ww  A  • 

1  The  Distribution  of  Wealth,  p.  404. 

2  Ibid.,  p.  405.  3  Ibid.,  p.  406. 

4  Ibid.,  p.  410.  This  is  fallacious  even  under  the  assumptions,  since 
the  profits  of  change  come  largely  in  the  form  of  readjustments  of  capital 
values.  The  difficulty  is,  of  course,  avoided  if  "friction"  be  so  broadly 
defined  that  "perfect  mobility"  means  the  absence  of  all  resistance  to 
the  human  will.  But  in  a  world  where  a  breath  could  transform  a  brick 
factory  building  into  a  railway  yard  or  an  ocean  greyhound  there  would 
be  no  need  for  economic  activity  or  economic  science. 


THEORIES  OF  PROFIT  35 

however  much  they  might  add  to  the  world's  productive 
power."  l 

The  fatal  criticism  of  this  procedure  of  taking  changes 
in  conditions  as  the  explanation  and  cause  of  profit  is  that 
it  overlooks  the  fundamental  question  of  the  difference 
between  a  change  that  is  foreseen  a  reasonable  time  in 
advance  and  one  that  is  unforeseen.  Now,  if  we  merely 
assume  that  all  the  "dynamic  changes"  which  Professor 
Clark  enumerates,  and  any  others  which  may  be  named, 
are  foreknown  for  a  sufficient  time  before  they  take  place,  or 
that  they  take  place  continuously  in  accordance  with  laws 
generally  and  accurately  known,  so  that  their  course  may 
be  predicted  as  far  into  the  future  as  occasion  may  require, 
then  the  whole  argument  based  on  the  effects  of  change  will 
fall  completely  to  the  ground.  If  the  retort  is  made  that 
this  is  a  supposition  contrary  to  fact  and  illicit,  the  answer 
is  that  it  is  only  partly  contrary  to  fact.  Some  changes  are 
foreseen  and  some  are  not,  the  laws  of  some  are  tolerably 
accurately  known,  of  others  hardly  at  all;2  and  the  vari- 

1  The  Distribution  of  Wealth,  p.  411.  At  this  point  Professor  Clark 
makes  a  statement  which  if  followed  out  would  lead  to  serious  question- 
ings in  regard  to  his  analysis:  "Profit,"  he  says  (p.  411),  "is  the  |n/e  that 
insures  improvement,  and  improvement  is  the  source  of  permanent  addi- 
tions to  wages.  To  secure  progress,  this  lure  must  be  sufficient  to  make 
men  overcome  obstructions  and  take  risks."  (My  italics.)  It  would  seem 
that  effort  and  risk  have  some  connection  with  the  income  of  the  "entre- 
preneur as  such,"  as  well  as  change  and  friction.  Along  the  same  line  is 
the  statement  in  his  first  chapter  (p.  3)  that  "free  competition  tends  to 
give  to  labor  what  labor  creates,  to  capitalists  what  capital  creates,  and 
to  entrepreneurs  what  the  coordinating  function  creates."  When  we  ask, 
as  we  presently  shall,  whether  the  "effort"  and  "risk"  connected  with 
making  progress,  or  the  income  to  which  they  give  rise,  are  essentially 
different  from  any  other  effort  and  risk  and  their  incomes,  we  shall  find 
ourselves  forced  to  answer  in  the  negative,  and  to  look  outside  the  fact 
of  change  altogether  for  an  explanation  of  the  unique  income  of  the 
entrepreneur. 

2  It  may  be  objected  that  in  regard  to  some  changes  it  is  an  absurdity 
to  imagine  their  being  foreseen,  since  this  would  cause  them  to  take  place 
at  once.  The  statement  doubtless  holds  in  regard  to  some  discoveries 
of  fact,  which  to  anticipate  would  be  to  make  them  now.  But  not  many 
of  the  dynamic  economic  changes  are  of  this  sort.   The  accumulation  of 


36  RISK,  UNCERTAINTY,  AND  PROFIT 

ation  in  foreknowledge  makes  it  clearly  indispensable  to 
separate  its  effects  from  those  of  change  as  such  if  any  real 
understanding  of  the  elements  of  the  situation  is  to  be 
attained.  It  is  evident  that  a  society  might  be  ever  so 
dynamic,  as  Professor  Clark  demies  the  term,  and  yet  have 
all  its  prices  "natural"  or  constantly  equal  to  production 
costs,  excluding  any  chance  for  the  entrepreneur  to  secure 
a  net  profit.  It  is  fallacious  to  define  "natural"  conditions 
as  "static"  conditions. 

No  a  priori  argument  is  necessary  to  prove  that  with 
general  foreknowledge  of  progressive  changes  no  losses  and 
no  chance  to  make  profits  will  arise  out  of  them.  This  is  the 
first  principle  of  speculation,  and  is  particularly  familiar  in 
the  capitalization  of  the  anticipated  increase  in  the  value  of 
land.  The  effect  of  any  change  which  can  be  foreseen  will 
be  adequately  discounted  in  advance,  any  "costs"  con- 
nected with  it  will  be  affected  in  exactly  the  same  way  as 
the  corresponding  "values"  and  no  separation  between  the 
two  will  take  place. 

It  will  be  interesting  to  follow  this  line  of  thought  some- 
what farther,  as  suggested  above  in  connection  with  Pro- 
fessor Clark's  characterization  of  profit  as  the  lure  that 
causes  men  to  make  the  efforts  and  take  the  risks  involved  in 
progress.  It  is  in  fact  but  a  short  step  from  the  foreknowl- 
edge of  change  to  the  fact  that  change  in  reality  does  not 
usually  just  happen,  but  is  largely  itself  the  result  of  hu- 
man activity.  It  is  evident  that  if  the  laws  of  economically 

capital  and  increase  in  population  are  in  fact  relatively  predictable  and 
the  broader  features  in  the  development  of  wants  are  known  and  the 
knowledge  has  no  effect  on  the  changes  themselves.  It  is  possible  even 
to  predict  discovery  of  natural  resources  without  saying  just  where  they 
will  be  found,  and  the  making  of  an  invention  without  actually  writing 
the  specifications.  The  probability  that  inventions  will  be  made  and 
processes  improved  is  in  fact  very  frequently  taken  into  account  in  mak- 
ing valuations  and  determining  business  policies.  The  assumption  that 
all  change  might  be  predictable  is  contrary  to  fact,  but  not  self-contra- 
dictory, and  we  leave  it  to  the  argument  as  a  whole  to  justify  its  useful- 
ness as  well  as  legitimacy. 


THEORIES  OF  PROFIT  37 

significant  changes  are  known,  those  human  actions  which 
give  rise  to  such  changes  will  be  governed  by  the  same 
motives  as  the  operations  productive  of  immediate  utili- 
ties, and  in  the  competition  of  resources  for  profitable  em- 
ployment returns  will  be  adjusted  to  equality  between  the 
two  fields  of  use.  Industrial  progress  would  certainly  take 
place  under  these  conditions  quite  as  readily  as  where  the 
operations  giving  rise  to  it  gave  highly  unpredictable  re- 
sults, but  the  rewards  of  making  inventions,  discovering 
new  natural  resources,  etc.,  with  the  speculative  character 
of  the  operations  once  removed,  would  be  in  no  wise  differ- 
ent from  wages,  interest,  and  rent  in  any  other  line  of  pro- 
ductive activity.  They  would  be  equal  in  amount,  deter- 
mined in  the  same  way,  in  the  same  competitive  market, 
and  in  short  would  be  wages,  interest,  and  rent  merely,  and 
not  profit.  And  this  is  what  does  come  about  to  the  extent 
that  progress  can  be  foreseen,  which  is  to  say  in  very  large 
measure.  Dynamic  changes  give  rise  to  a  peculiar  form  ofl 
income  only  in  so  far  as  the  changes  and  their  consequences  j 
are  unpredictable  in  character. 

It  cannot,  then,  be  change,  which  is  the  cause  of  profit, 
since  if  the  law  of  the  change  is  known,  as  in  fact  is  largely  the 
case,  no  profits  can  arise.  The  connection  between  change 
and  profit  is  uncertain  and  always  indirect.  Change  may 
cause  a  situation  out  of  which  profit  will  be  made,  if  it 
brings  about  ignorance  of  the  future.  Without  change  of 
some  sort  there  would,  it  is  true,  be  no  profits,  for  if  every- 
thing moved  along  in  an  absolutely  uniform  way,  the 
future  would  be  completely  foreknown  in  the  present  and 
competition  would  certainly  adjust  things  to  the  ideal  state 
where  all  prices  would  equal  costs.  It  is  this  fact  that 
change  is  a  necessary  condition  of  our  being  ignorant  of  the 
future  (though  ignorance  need  not  follow  from  the  fact  of 
change  and  only  to  a  limited  extent  does  so)  that  has  given 
rise  to  the  error  that  change  is  the  cause  of  profit. 

Not  only  may  change  take  place  without  occasioning 


38  RISK,  UNCERTAINTY,  AND  PROFIT 

profit,  but  profit  may  also  arise  in  the  entire  absence  of 
any  "dynamic'*  or  progressive  changes  of  the  kind  enu- 
merated by  Professor  Clark.    If  conditions  are  subject  to 
unpredictable  fluctuations,1  ignorance  of  the  future  will 
result  in  the  same  way  and  inaccuracies  in  the  competitive 
adjustment  and  profits  will  be  the  inevitable  consequence. 
And  the  failure  of  an  anticipated  change  to  occur  is  the 
game  in  effect  as  the  occurrence  of  an  unanticipated  one. 
•  It  is  not  dynamic  change,  nor  any  change,  as  such,  which 
I  causes   profit,  but  the   divergence  of  actual   conditions 
lfrom  those  which  have  been  expected  and  on  the  basis  of 
!  which  business  arrangements  have  been  made.   For  a  sat- 
isfactory explanation  of  profit  we  seem  to  be  thrown  back 
from  the  "dynamic"  theory  to  the   Uncertainty  of  the 
Future,  a  condition  of  affairs  loosely  designated  by  the 
term  "risk"  in  ordinary  language  and  in  business  par- 
lance. 

Except  for  one  or  two  passing  references,  Professor  Clark 
does  not  take  up  the  subject  of  risk  in  the  treatise  from 
which  we  have  quoted.  In  a  short  article  on  "Insurance 
and  Profits"2  (written  in  refutation  of  Mr.  Hawley)  he 
takes  the  position  that  risk-taking  gives  rise  to  a  special 
category  of  income,  but  that  it  accrues  to  the  capitalist, 
and  cannot  go  to  the  entrepreneur,  as  such.  How  he  would 
treat  this  income,  what  relation  it  would  bear  to  interest,  he 
does  not  tell  us.  But  it  is  no  part  of  profit,  which  is  de- 
fined as  "the  excess  of  the  price  of  goods  over  their  cost."3 
"It  goes  without  saying  that  the  hazard  of  business  falls 
on  the  capitalist.  The  entrepreneur,  as  such,  is  empty- 
handed.  No  man  can  carry  risk  who  has  nothing  to  lose."4 
In  his  later  work,  the  "Essentials  of  Economic  Theory," 

1  It  is  necessary  to  stipulate  that  the  fluctuations  must  be  of  sufficient 
extent  and  irregularity  that  they  do  not  cancel  out  and  reduce  to  uniform- 
ity or  regular  periodicity  in  a  time-interval  short  in  comparison  with  the 
length  of  human  life. 

2  Quarterly  Journal  of  Economics,  vol.  vn,  pp.  40-54. 
8  Ibid.,  p.  41.  *  Ibid.,  p.  46. 


THEORIES  OF  PROFIT  39 

the  subject  of  risk  again  receives  scant  attention.1  Risks 
are  simply  ruled  out  of  the  discussion,  since  "the  greater 
part  of  them  arise  from  dynamic  causes,"  and  the  "un- 
avoidable remainder"  of  static  risk  can  be  taken  care  of  by 
setting  aside  "a  small  percentage  of  the  annual  gains  [of 
each  establishment,  which]  .  .  .  will  make  good  these  losses 
as  they  occur  and  leave  the  businesses  in  a  condition  in 
which  they  can  yield  as  a  steady  return  to  owners  of  stock, 
to  lenders  of  .  .  .  capital,  and  to  laborers  all  of  their  real 
product." 

It  is  clear  that  Professor  Clark  admits  that  his  perfectly 
competitive  state  implies  substantially  perfect  knowledge 
on  the  part  of  all  members  of  society  of  present  and  future 
facts  significant  for  the  ordering  of  their  business  conduct. 
Dr.  A.  H.  Willett2  has  supplemented  the  theory  of  the 
static  state  in  this  field,  and  Dr.  A.  S.  Johnson  has  some  dis- 
cussion of  it  in  his  study  of  rent.3  Willett  recognizes  that 
the  disturbing  effects  of  progress  do  not  constitute  the  sole 
cause  of  divergence  between  actual  society  and  the  theo- 
retical ideal;  "the  conception  of  the  static  state  is  reached 
by  a  process  of  abstraction,"  which  "cannot  stop"  with 
the  elimination  of  the  five  dynamic  changes : 

If  all  dynamic  changes  were  to  cease,  the  ideal  static  state 
would  never  be  realized  in  human  society.  There  are  other  as- 
sumptions which  have  to  be  made,  such  as  a  high  degree  of 
mobility  of  capital  and  labor,  the  universal  prevalence  of  the 
economic  motive,  and  the  power  of  accurately  foreseeing  the 
future.  .  .  . 

It  is  the  influence  of  the  last  of  these  disturbing  factors  on 
static  rates  of  wages  and  interest  that  we  are  to  seek  to  deter- 
mine. The  ideal  adjustment  could  be  realized  only  on  the  condi- 

1  Footnote,  pp.  122-23. 

2  The  Economic  Theory  of  Risk  and  Insurance,  Columbia  University 
Studies  in  Political  Science,  vol.  xiv,  no.  2. 

3  Rent  in  Modern  Economic  Theory.  Publications  of  the  American 
Economic  Association,  3d  Series,  vol.  in,  no.  4.  See  chapter  vi:  "Rent, 
Profit,  and  Monopoly  Return."  (Both  these  monographs  are  doctoral 
dissertations  written  under  Professor  Clark's  supervision.) 


40  RISK,  UNCERTAINTY,  AND  PROFIT 

tion  that  there  were  no  discrepancies  between  the  anticipated  and 
the  actual  results  of  economic  activity.  Production  and  consump- 
tion must  go  on  either  with  absolute  uniformity  or  with  a  regular 
periodicity.1 

t1  From  the  above  admission  that  the  static  state  is  not  an 
adequate  formulation  of  the  conditions  of  ideal  competi- 
tion, it  would  be  an  easy  inference  in  line  with  static  theory 
as  a  whole  that  some  modification  in  the  treatment  of 
profit  would  be  called  for.  But  this  inference  is  not  drawn 
by  the  author  quoted.  He  is  not  looking  for  and  does  not 
find  any  connection  between  profit  and  risk.  He  agrees 
explicitly  with  Clark  that  the  entrepreneur  takes  risk  only 
as  a  capitalist,  and  that  the  income  resulting  is  therefore 
not  profit.  In  his  discussion  of  the  reward  for  risk-taking, 
Willett  states  even  more  emphatically  than  Clark  had  done 
the  contention  that  only  the  capitalist  as  such  can  take 
risk  or  get  the  reward  of  risk-assumption.  To  him  this 
"seems  to  be  a  self-evident  proposition,"2  but  he  fails  to 
take  account  of  the  familiar  fact  that  men  may  secure  their 
obligations  in  other  ways  than  through  pledging  material 
resources  already  owned  and  invested,  as  for  example  by 
mortgaging  their  current  income  from  all  sources  and  their 
future  earning  power. 

In  his  discussion  of  profits  referred  to  above,  Dr.  John- 
son makes  some  reference  to  risk,  but  he  also  makes  no 
attempt  to  find  in  it  an  explanation  of  profit.  He  dis- 
covers four  elements  in  "the  income  of  a  fortunate  and 
capable  entrepreneur." 

(1)  A  gain  due  to  chance,  offset  by  a  smaller  loss  (borne,  how- 
ever, by  some  other  entrepreneur);  (2)  a  gain  due  to  his  own 
power  of  combining  labor  and  capital  in  ways  more  effective  than 
those  usually  employed  in  the  community;  (3)  a  certain  share  in 
the  first  fruits  of  economic  improvements;  (4)  a  part  of  the  gains 
which  entrepreneurs  as  a  class  secure  through  the  fact  that  their 
services  are  limited  in  proportion  to  the  demand  for  them. 

1  Willett,  op.  cit.t  pp.  13-14.  (My  italics.) 

2  Ibid.,  p.  72. 


THEORIES  OF  PROFIT  41 

We  need  not  stop  to  criticize  this  analysis  in  detail;  it 
might  be  pointed  out  that  shares  (2)  and  (4)  are  identical, 
and  that  neither  formulation  would  distinguish  profit 
from  wages  (and  (4)  not  from  any  other  income,  as  we  have 
remarked  above);  (3)  is  a  reference  to  the  "dynamic"  ex- 
planation of  profit  and  is  unclear  without  further  elabora- 
tion; (1)  seems  to  point  to  a  connection  between  profit 
and  risk,  but  this  is  not  worked  out.  It  is  clear  that  these 
discussions  of  risk,  as  emendations  of  the  dynamic  theory, 
make  no  pretense  of  explaining  the  connection  between 
profit  and  uncertainty  which  our  discussion  of  Professor 
Clark's  treatment  showed  to  be  necessary.  Both  writers 
are,  indeed,  opposed  to  and  attempt  to  refute  the  doctrine 
that  profit  is  the  result  of  assuming  risk. 

The  doctrine  that  profit  is  to  be  explained  exclusively 
in  terms  of  risk  has  been  vigorously  upheld  by  Mr.  F.  B. 
Hawley,1  who  finds  in  risk-taking  the  essential  function  of 
the  entrepreneur  and  therefore  the  basis  of  his  peculiar  in- 
come. In  Mr.  Hawley's  distributive  theory  the  entre- 
preneur, or  "enterpriser"  as  he  is  called,  plays  a  role  of 
unique  importance.  Enterprise  is  the  only  really  produc- 
tive factor,  strictly  speaking,  land,  labor,  and  capital  be- 
ing relegated  to  the  position  of  "means"  of  production. 
In  regard  to  profit,  the  reward  of  enterprise,  Hawley  says: 2 

1  The  most  complete  exposition  of  Hawley's  theory  is  in  his  book. 
Enterprise  and  the  Productive  Process  (1907).  Articles  of  earlier  date  in 
the  Quarterly  Journal  of  Economics  contain  briefer  statements. 

2  An  earlier  attempt  by  Mr.  Hawley  to  present  the  essentials  of  his 
theory  in  the  most  compact  form  is  superior  in  some  respects  and  is 
worth  quoting: 

"The  final  consumer  is  forced  to  include  in  the  price  he  pays  for  any 
product  not  only  enough  to  cover  all  the  items  of  cost  to  the  entre- 
preneur, —  among  which  items  is  a  sum  sufficient  to  cover  the  actuarial 
or  average  losses  incidental  to  the  various  risks  of  all  kinds  necessarily 
assumed  by  the  entrepreneur  and  his  insurers,  —  but  a  further  sum,  with- 
out which,  as  an  inducement,  the  entrepreneur,  or  enterpriser,  and  his 
insurers  will  not  undergo  or  suffer  the  irksomeness  of  being  exposed  to 
risk. 

"This  surplus  of  consumer's  cost  over  entrepreneur's  cost,  universally 


42  RISK,  UNCERTAINTY,  AND  PROFIT 

.  .  .  the  profit  of  an  undertaking,  or  the  residue  of  the  product 
after  the  claims  of  land,  capital,  and  labor  (furnished  by  others 
or  by  the  undertaker  himself)  are  satisfied,  is  not  the  reward  of 
management  or  coordination,  but  of  the  risks  and  responsibilities 
that  the  undertaker  .  .  .  subjects  himself  to.  And  as  no  one,  as  a 
matter  of  business,  subjects  himself  to  risk  for  what  he  believes 
the  actuarial  value  of  the  risk  amounts  to  —  in  the  calculation 
of  which  he  is  on  the  average"  correct  —  a  net  income  accrues  to 
Enterprise,  as  a  whole,  equal  to  the  difference  between  the  gains 
derived  from  undertakings  and  the  actual  losses  incurred  in  them. 
This  net  income,  being  manifestly  an  unpredetermined  residue, 
must  be  a  profit,  and  as  there  cannot  be  two  unpredetermined 
residues  in  the  same  undertaking,  profit  is  identified  with  the  re- 
ward for  the  assumption  of  responsibility,  especially,  though  not 
exclusively,  that  involved  in  ownership,1 

Mr.  Hawley  is  in  agreement  with  Professor  Clark  and 
his  followers  in  defining  profit  as  "residual  income,"  and 
as  to  the  nature  and  basis  of  the  special  income  connected 
with  the  assumption  of  risk  as  an  excess  of  payment  above 
the  actuarial  value  of  the  risk,  demanded  because  exposure 
to  risk  is  "irksome";  but  Hawley  insists  that  residual  in- 
come and  uncertain  income  are  interchangeable  concepts,2 
while  Clark  is  equally  sure  that  the  reward  of  risk-taking 
necessarily  goes  to  the  capitalist  as  such  and  that  the  pure 
profit  of  the  entrepreneur  is  a  species  of  monopoly  gain 
arising  in  connection  with  dynamic  disturbances,  and  that 
his  only  income  under  static  conditions  would  be  wages  of 
management  or  coordination.  Hawley  contends  that  such 

regarded  as  profit,  and,  from  the  nature  of  the  case,  an  unpredetermined 
residue,  is  the  inducement  for  the  assumption  by  the  entrepreneur,  or 
enterpriser,  of  all  the  risks,  whatever  their  nature,  necessitated  by  the 
process  of  production.  As  the  inducement  to  any  given  action  and  the 
reward  for  that  action  are  the  same  thing,  —  the  difference  being  not 
in  the  thing  itself,  but  only  in  the  point  of  time  from  which  it  is  looked 
upon,  —  the  unpredetermined  residue,  which  served  as  the  inducement 
to  risk  at  the  commencement  of  any  industrial  transaction  must  necessa- 
rily, when  determined  and  realized  at  its  close,  be  regarded  as  the  result, 
reward,  of  the  risks  undergone."  {Quarterly  Journal  of  Economics,  vol. 
xv,  pp.  603-20.)     (In  the  original  the  portion  quoted  is  all  in  italics.) 

1  Op.  cit,  pp.  106-07. 

2  Quarterly  Journal  of  Economics,  vol.  vn,  p.  465;  vol.  xv,  p.  88. 


THEORIES  OF  PROFIT  43 

income  is  wages  merely,  and  not  profit,  and  does  not 
distinguish  between  "static"  and  "dynamic"  conditions. 
Coordination,  however,  is  in  his  view  distinguished  from 
labor  by  the  fact  of  proprietorship,  "which  is  the  very 
essence  of  the  matter  in  dispute."1  Profit  cannot  be  the 
reward  of  management,  for  this  can  be  performed  by  hired 
labor  if  the  manager  takes  no  risk,  but  this  individual  is  no 
longer  an  entrepreneur. 

It  is  admitted  that  the  entrepreneur  may  get  rid  of  risk 
in  some  cases  for  a  fixed  cost,  by  means  of  insurance.  But 
by  the  act  of  insurance  the  business  man  abdicates  so  much 
of  his  entrepreneurship,  "for  it  is  manifest  that  an  entre- 
preneur who  should  eliminate  all  his  risks  by  means  of  in- 
surance would  have  left  no  income  at  all  which  was  not 
resolvable  into  wages  of  management  and  monopoly 
gains"  (i.e.,  no  profit).2  To  the  extent  to  which  the  busi- 
ness man  insures,  he  restricts  the  exercise  of  his  peculiar 
function,  but  the  risk  is  merely  transferred  to  the  insurer, 
who  by  accepting  it  becomes  himself  an  enterpriser  and  the 
recipient  of  an  unpredetermined  residue  or  profit.  "The 
reward  of  an  insurer  is  not  the  premium  he  receives,  but  the 
difference  between  that  premium  and  the  loss  he  eventu- 
ally suffers."  3 

The  clue  to  the  disagreement  and  to  the  straightening- 
out  of  the  facts  as  well  is  to  be  found  in  a  confusion 
fallen  into  by  those  on  both  sides  of  the  controversy,  in 
assuming  that  the  "actuarial  value"  of  the  risks  taken  is 
known  to  the  entrepreneur.  There  is  a  fundamental  dis- 
tinction between  the  reward  for  taking  a  known  risk  and 

1  "Enterprise  and  Profit,"  Quarterly  Journal  of  Economics,  vol.  xv, 
p.  86. 

2  Quarterly  Journal  of  Economics,  vol.  vii,  p.  464.  It  should  be  ex- 
plained that  "monopoly  gain"  for  Mr.  Hawley  includes  all  income  due 
to  limitation,  and  he  finds  that  it  forms  a  considerable  portion  of  wages 
and  interest,  all  of  rent,  and  a  large  part  of  profit.  We  have  repeatedly 
observed  examples  of  this  fallacy  and  remarked  that  there  is  no  income 
which  is  not  due  to  the  "scarcity"  of  the  agent  securing  it. 

3  Enterprise  and  the  Productive  Process,  p.  111. 


44  RISK,  UNCERTAINTY,  AND  PROFIT 

that  for  assuming  a  risk  whose  value  itself  is  not  known. 
It  is  so  fundamental,  indeed,  that,  as  we  shall  see,  a  known 
risk  will  not  lead  to  any  reward  or  special  payment  at  all. 
Though  Willett  distinguishes  between  "uncertainty"  and 
"risk"  and  the  mathematical  probability  of  loss,1  he  still 
treats  uncertainty  throughout  his  study  as  a  known  quan- 
tity.2 The  same  applies  to  Johnson;  he  also  implicitly  rec- 
ognizes at  various  points  that  the  true  chance  or  actuarial 
value  of  the  risk  may  not  be  known,  and  devotes  some 
space 3  to  Thunen's  emphasis  on  the  distinction  between 
insurable  and  uninsurable  risks;  but  he  also  fails  entirely  to 
take  account  in  his  discussion  of  profit  of  the  fact  that  the 
risk  involved  in  entrepreneurship  is  not  and  cannot  be  a 
known  quantity. 

In  a  similar  way  Hawley  repeatedly  refers  to  the  fact  of 
uninsurable  risk  as  well  as  to  "pure  luck"  and  to  "changes 
that  no  one  could  have  foreseen,"  but  he  fails  to  inquire 
into  its  meaning  or  to  recognize  its  theoretical  import.4 
Once  he  goes  so  far  as  to  say  that  "the  great  source  of 

1  Op.  cit.,  pp.  27  ff. 

2  Risk  is  defined  as  "the  objective  correlative  of  the  subjective  un- 
certainty" (p.  29),  which  varies  with  the  mathematical  chance  of  loss  in 
such  a  way  as  to  be  at  a  maximum  when  the  chances  for  and  against  the 
event  are  exactly  even.  But  it  is  still  to  be  regarded  as  a  known  quantity, 
since  the  mathematical  chance  is  assumed  to  be  known.  Willett  nowhere 
makes  an  explicit  statement  on  this  point,  as  Hawley  does  (see  quotation 
in  text  on  p.  42  above),  but  his  discussion  clearly  shows  that  it  is  viewed 
as  a  known  quantity.  He  takes  his  illustrations  from  games  of  chance  or 
from  the  field  of  insurance,  speaks  of  the  influence  of  "a  given  degree  of 
risk"  (p.  65)  on  investors,  etc.  He  does  recognize  the  fact  that  the  degree 
of  risk  is  not  always  known  in  fact,  and  discusses  methods  of  estimating 
the  degree  of  risk;  but  (pp.  66  and  76)  he  expressly  eliminates  from  the 
discussion  the  consequences  of  error  in  estimating  the  true  value  of  the 
risk. 

8  Op.  cil.t  p.  112. 

4  The  reader  will  recall  that  many  of  the  early  discussions  of  profit 
(discussed  in  the  early  pages  of  this  chapter),  notably  those  of  v.  Man- 
goldt  and  v.  Thunen,  recognized  the  fact  that  some  risks  are  insurable 
and  others  are  not.  No  explanation  of  the  fact,  however,  has  been  given, 
beyond  phrases  such  as  "in  the  nature  of  the  case,"  which  imply  that  it 
does  not  call  for  explanation. 


THEORIES  OF  PROFIT  45 

monopoly  profit  is  to  be  found  in  the  fact  that  the  actuarial 
risk  of  any  given  undertaking  is  not  the  same  for  different 
entrepreneurs,  owing  to  differences  among  them  in  ability 
and  environment";1  and  again,  that  "profit  is  the  result  of 
risks  wisely  selected."  2  Even  here,  however,  he  fails  to 
develop  the  point  and  draw  the  consequences  from  the  fact 
that  the  actuarial  value  of  the  risk  undergone  by  any  ven- 
turer is  not  known,  either  to  himself  or  to  his  competitors. 

In  a  sense  Mr.  Hawley  comes  still  nearer  to  the  crux  of 
the  matter  in  his  insistence  on  the  responsibility  and  risk  of 
proprietorship  as  the  essential  attributes  of  entrepreneur- 
ship.  The  entrepreneur  is  the  owner  of  all  real  wealth,  and 
ownership  involves  risk;  the  coordinator  "makes  decisions," 
but  it  is  the  entrepreneur  who  "accepts  the  consequences  of 
decisions."  3  He  admits  that  others  than  the  recognized 
entrepreneur  are  subject  to  risk;  the  landlord  is  also  a  pro-, 
prietor,  and  his  land  may  change  in  value;  the  capitalist  \ 
especially  requires  payment  for  the  large  risks  he  runs,  and 
a  part  of  both  rent  and  interest  is  accordingly  profit.  _A  : 
person  who  invests  his  own  capital  in  any  form  of  opportu- 
nity necessarily  combines  the  two  functions  of  capitalist 
and  enterpriser.  The  same  should  apparently  apply  to  the 
\Jaborer,  who  is  also  admitted  to  run  risks. 

Mr.  Hawley  does  not  regard  the  term  "risk"  as  calling 

for  special  definition,  but  it  is  clear  that,  like  the  other 

writers,  he  treats  it  as  a  known  quantity;  he  says  this  much 

1  "The  Risk  Theory  of  Profit,"  Quarterly  Journal  of  Economics,  vol. 
Vii,  p.  468. 

*  Enterprise  and  the  Productive  Process,  p.  108.  Cf.  Carver,  "Risk 
Theory  of  Profits,"  Quarterly  Journal  of  Economics,  vol.  xv,  pp.  456  ff., 
and  The  Distribution  of  Wealth,  chap.  vii.  Also  A.  A.  Young  in  Ely's 
Outlines  of  Economics,  3d  ed.,  chap.  xxv.  The  phrase  "successful  risk- 
taking,"  used  by  both  Carver  and  Young,  like  Hawley's  "risks  wisely 
selected,"  is  certainly  descriptive  of  the  origin  of  profits.  What  is  wanted 
is  an  examination  of  the  meaning  of  risk-taking  which  will  elucidate  the 
conditions  under  which  it  will  be  successful  and  show  the  significant 
differences  between  cases  of  success  and  cases  of  failure. 

*  "Enterprise  and  Profit,"  Quarterly  Journal  of  Economics,  vol.  xv, 
p.  88. 


46  RISK,  UNCERTAINTY,  AND  PROFIT 

explicitly.1  He  and  his  opponents  alike  have  failed  to  ap- 
preciate the  fundamental  difference  between  a  determinate 
uncertainty  or  risk  and  an  indeterminate,  unmeasurable 
one.  The  only  practical  bearing  of  the  question  as  to 
whether  the  value  of  the  risk  is  known  which  is  recognized 
by  Hawley  is  to  determine  whether  it  is  likely  to  be  insured, 
which  is  to  say  merely  who  will  get  the  "profit"  for  as- 
suming it;  even  this  point  is  not  very  explicitly  made. 
Now  a  little  consideration  will  show  that  there  can  be  no 
considerable  "irksomeness"  attached  to  exposure  to  an  in- 
surable risk,  for  if  there  is  it  will  be  insured;  hence  there 
can  be  no  peculiar  income  arising  out  of  this  alleged  in- 
disposition. If  risk  were  exclusively  of  the  nature  of  a 
known  chance  or  mathematical  probability,  there  could  be 
no  reward  of  risk-taking;  the  fact  of  risk  could  exert  no 
considerable  influence  on  the  distribution  of  income  in  any 
way.  For  if  the  actuarial  chance  of  gain  or  loss  in  any  trans- 
action is  ascertainable,  either  by  calculation  a  priori  or  by 
the  application  of  statistical  methods  to  past  experience, 
the  burden  of  bearing  the  risk  can  be  avoided  by  the  pay- 
ment of  a  small  fixed  cost  limited  to  the  administrative 
expense  of  providing  insurance.  s 

The  fact  is  that  while  a  single  situation  involving  a 
known  risk  may  be  regarded  as  "uncertain,"  this  uncer- 
tainty is  easily  converted  into  effective  certainty;  for  in 
a  considerable  number  of  such  cases  the  results  become 
predictable  in  accordance  with  the  laws  of  chance,  and  the 
error  in  such  prediction  approaches  zero  as  the  number  of 
cases  is  increased.  Hence  it  is  simply  a  matter  of  an  elef 
mentary  development  of  business  organization  to  com- 
bine a  sufficient  number  of  cases  to  reduce  the  uncertainty 
to  any  desired  limits.  This  is,  of  course,  what  is  accom- 
plished by  the  institution  of  insurance. 

It  is  true  that  the  person  subject  to  such  a  risk  may 
voluntarily  choose  not  to  insure,  but  it  is  hard  to  distin- 
1  See  above,  p.  42. 


THEORIES  OF  PROFIT  47 

guish  such  a  course  from  deliberate  gambling,  and  econo- 
mists have  not  felt  constrained  to  recognize  gambling  gains 
in  general  as  a  special  income  category  in  the  theory  of  dis- 
tribution. If  it  is  objected  that  practical  difficulties  may 
prevent  insurance  even  where  the  risk  is  determinate,  the 
reply  is  that  insurance,  in  the  technical  sense,  is  only  one 
method  of  applying  the  same  principle.  We  shall  show  at 
length  in  our  general  discussion  of  risk  and  uncertainty 
that  if  the  risk  is  measurable,  but  the  "moral  factor"  or 
some  other  consideration  makes  ordinary  insurance  in- 
applicable, some  other  method  of  securing  the  same  result 
will  be  developed  and  employed.  When  the  technique  of 
business  organization  has  reached  a  fairly  high  stage  of 
development  a  known  degree  of  uncertainty  is  practically 
no  uncertainty  at  all,  for  such  risks  will  be  borne  in  groups 
large  enough  to  reduce  the  uncertainty  to  substantially 
negligible  proportions. 

The  result  of  the  foregoing  analysis  should  be  to  show  the 
inadequacy  of  the  two  opposed  theories  of  profit  and  to  in- 
dicate the  reasons  for  it  and  the  direction  in  which  a  tenable 
solution  of  the  problem  of  profit  is  to  be  sought.  It  has 
been  seen,  first,  that  change  as  such  cannot  upset  the  com- 
petitive adjustment  if  the  law  of  the  change  is  known;  and 
now,  secondly,  that  an  unpredictable  change  will  be  simi- 
larly ineffective  if  the  chance  of  its  occurrence  can  be 
measured  in  any  way.  In  a  well-organized  society,  if 
business  men  know  either  (1)  what  actual  changes  are  im- 
pending or  (2)  the  "risks"  they  run  —  i.e.,  what  is  the 
probability  of  any  particular  occurrence,  —  the  effect  in 
the  long  run  is  the  same;  the  only  result  of  such  changes 
will  be  a  certain  redistribution  of  productive  energy  which 
will  take  place  continuously  and  without  any  disturbance 
of  perfect  competitive  conditions.1  The  fact  that  predic- 

1  It  must  be  understood  that  by  laws  and  chances  being  "known," 
we  mean  that  they  are  generally  known,  known  to  all  to  whom  they  are  of 
any  concern. 


48  RISK,  UNCERTAINTY,  AND  PROFIT 

tion  may  involve  costs,  and  likewise  the  organization  for 
grouping  risks  and  eliminating  their  uncertainty,  does  not 
negate  the  truth  of  the  proposition,  so  long  as  these  costs 
are  given  elements  in  the  competitive  situation. 

Yet  it  is  equally  evident  that  there  is  a  principle  of  truth 
in  both  the  "dynamic"  and  the  "risk"  theories,  and  the 
true  theory  must  to  a  considerable  degree  reconcile  the  two 
views.  On  the  one  hand,  profit  is  in  fact  bound  up  in 
economic  change  (but  because  change  is  the  condition  of 
uncertainty),  and  on  the  other,  it  is  clearly  the  result  of 
risk,  or  what  good  usage  calls  such,  but  only  of  a  unique 
kind  of  risk,  which  is  not  susceptible  of  measurement. 
The  Clark  school  has  confused  change  with  a  common  but 
not  universal  or  necessary  implication  of  change,  and  both 
schools  have  followed  everyday  speech  into  the  fallacy  of 
treating  risk  as  a  substantially  homogeneous  category, 
where  a  fundamental  difference  in  kinds  of  risk  is  in  fact 
the  key  to  the  whole  mystery. 

The  meaning  of  "uncertainty,"  and  of  the  different 
kinds  of  uncertainties,  and  their  significance  in  competitive 
economic  relations,  will  therefore  constitute  the  principal 
subject  which  we  have  finally  to  investigate  in  the  present 
study.  The  next  step  in  the  progress  of  the  argument  will 
be  to  lay  a  comparative  basis  for  this  investigation  by  at- 
tempting to  gain  a  clear  view  of  the  mechanism  of  com- 
petitive valuation  and  distribution  as  they  would  be  if  un- 
certainty and  its  correlative  profit  were  entirely  absent. 
The  next  three  chapters  will  therefore  be  taken  up  with  an 
examination  of  the  conditions  and  workings  of  a  perfectly 
competitive  society;  of  these  conditions  the  crucial  one 
will  constantly  appear  as  the  possession  of  accurate  and 
certain  knowledge  of  the  whole  economic  situation  by  all 
the  competitors. 


PART  TWO 
PERFECT  COMPETITION 


CHAPTER  III 

THE  THEORY  OF  CHOICE  AND  OF  EXCHANGE 

We  turn  now  from  historical  and  critical  considerations 
to  the  real  work  of  construction.  We  have  seen  that  the 
historic  body  of  economic  theory  rests  upon  the  assumption 
of  perfect  competition,  but  that  the  precise  character  of 
this  assumption  has  been  partially  implicit  and  never  ade- 
quately formulated.  We  do  not  criticize  the  older  econ- 
omists for  making  abstract  assumptions  in  order  to  sim- 
plify and  analyze  their  problem,  but  contend  that  the 
assumptions  actually  made  and  their  implications  need  to 
be  brought  to  the  surface  and  emphasized.  To  display 
these  implicit  premises  of  theoretical  reasoning  is,  we  have 
argued,  to  explain  the  problem  of  profit,  the  absence  of 
which  is  the  essential  distinction  between  theoretical  and 
actual  economic  society.  This  explanation  will  immediately  ^. 
take  the  form  of  a  general  inquiry  into  "Uncertainty,"  the  \ 
presence  or  absence  of  which  will  appear  as  the  most  \ 
important  underlying  difference  *  between  the  conditions  } 
which  theory  is  compelled  to  assume  and  those  which 
exist  in  fact.  The  present  chapter  and  the  two  next  follow- 
ing will  be  taken  up  with  the  attempt  to  define  and  analyze 
perfect  competition.  The  argument  is  to  be  regarded  as  a 
condensed  summary  of  classical  economic  theory,  with  es- 
pecial reference  to  and  emphasis  upon  those  premises  and 
implications  which  have  not  been  adequately  emphasized 
in  the  theory  itself  and  have  been  liable  to  escape  the  ob- 
servation of  its  readers.  Aside  from  this  special  emphasis 
the  argument  will  differ  not  a  great  deal  from  that  of  J.  S. 
Mill  and  very  little  from  Marshall's  "Principles." 

Economics  is  a  human  science;  its  foundations  are  laid  in 
1  Outside  of  monopoly  considerations.  But  see  chapter  VI. 


52  RISK,  UNCERTAINTY,  AND  PROFIT 

the  principles  of  human  behavior,  and  consequently  we 
must  begin  with  some  observations  on  the  psychology  of 
human  conduct  which  controls  economic  life.  Economic 
analysis  may  be  truly  said  to  deal  with  "conduct,"  in  the 
Spencerian  sense  of  acts  adapted  to  ends,  or  of  the  adapta- 
tion of  acts  to  ends,  in  contrast  with  the  broader  category 
of  "behavior"  in  general.  It  assumes  that  men's  acts  are 
ruled  by  conscious  motives;  that,  as  it  is  more  ordinarily 
expressed,  they  are  directed  toward  the  "satisfaction  of 
wants."  1  At  the  very  outset  the  science  is  thus  subjected 
to  notable  restrictions,  since  it  is  only  to  a  limited  extent 
that  our  behavior,  even  our  economic  behavior,  is  of  this 
character.  Much  of  it  is  more  or  less  impulsive  and  capri- 
cious. The  conclusions  of  economic  theory  must  in  general 
be  admitted  subject  to  the  qualification,  in  so  far  as  men's 
economic  activities  are  rational  or  planned. 

This  limitation  is  far  more  sweeping  in  its  scope  and  im- 
port than  is  easily  imagined.  It  raises  the  fundamental 
question  of  how  far  human  behavior  is  inherently  subject 
to  scientific  treatment.  In  his  views  on  this  point  the 
writer  is  very  much  of  an  irrationalist.   In  this  view  the 

1  This  is  intended  as  a  statement  of  historic  fact,  not  a  dogma  of 
necessity  or  desirability.  To  the  extent  that  in  behavior  of  any  other  sort 
principles  may  be  discovered  of  a  sufficiently  general  applicability  to  en- 
able useful  conclusions  to  be  drawn  from  them,  there  is  no  reason  why 
such  principles  should  not  be  incorporated  in  the  premises  of  pure  theory. 
On  the  other  hand,  it  is  indisputably  legitimate  to  begin,  as  an  early  ap- 
proximation to  reality,  with  the  assumption  that  all  the  behavior  of  which 
we  treat  is  of  the  character  which  certainly  belongs  to  a  great  part  of  it. 
In  any  case  we  have  to  separate  fundamental  tendencies  by  such  a  proc- 
ess of  analysis  (i.e.,  abstraction)  if  we  are  to  know  anything  about  them 
individually.  Here  we  are  not  concerned  to  inquire  into  the  possibilities 
of  an  economics  of  instinct  and  reflex,  much  less  to  build  up  the  science; 
we  rest  on  the  fact  that  the  historic  body  of  speculation  has  dealt  with 
that  section  of  behavior  which  we  call  "conduct,"  and,  in  line  with  our 
leading  aim,  point  out  the  corresponding  limitations  of  the  conclusions 
from  the  reasoning.  It  would  be  futile  to  insist  further  (for  those  who 
have  not  grasped  the  point  already)  that  limitations  are  no  valid  ob- 
jection to  a  theory,  —  may  even  be  a  condition  of  its  having  any  worth, 
—  but  the  limitations  must  be  recognized  and  appreciated. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE      53 

whole  interpretation  of  life  as  activity  directed  toward 
securing  anything  considered  as  really  wanted,  is  highly 
artificial  and  unreal.  To  be  sure,  this  characterization  seems 
to  hold  good  for  an  individual  at  a  given  time  and  place,  if 
the  time  is  short  enough.  It  is  the  way  we  think  of  our- 
selves as  acting,  not  for  the  sake  of  the  action  or  experience 
itself,  but  in  order  to  some  ulterior  object.  If,  however,  the 
object  is  merely  accidental  and  temporary,  such  "wants" 
are  of  little  service  in  interpreting  an  economic  process 
which  must  look  far  forward.  It  is  the  writer's  belief  that 
this  view  of  behavior,  even  though  it  is  the  view  taken  by 
the  subject  himself,  is  superficial  at  best.  It  appears  that  a 
relatively  small  fraction  of  the  activities  of  civilized  man 
are  devoted  to  the  gratification  of  needs  or  desires  having 
any  foundation  beyond  the  mere  fact  that  an  impulse 
exists  at  the  moment  in  the  mind  of  the  subject/ 

Most  human  motives  tend  on  scrutiny  to  assimilate 
themselves  to  the  game  spirit.  It  is  little  matter,  if  any, 
what  we  set  ourselves  to  do;  it  is  imperative  to  have 
some  objective  in  view,  and  we  seize  upon  and  set  up  for 
ourselves  objectives  more  or  less  at  random  —  getting  an 
education,  acquiring  skill  at  some  art,  making  money,  or 
what-not.  But  once  having  set  ourselves  to  achieve  some 
goal  it  becomes  an  absolute  value,  weaving  itself  into  and 
absorbing  life  itself.  It  is  just  as  in  a  game  where  the  con- 
crete objective  —  capturing  our  opponents'  pieces,  carry- 
ing a  ball  across  a  mark,  or  whatever  it  may  be  —  is  a 
matter  of  accident,  but  to  achieve  it  is  for  the  moment  the 
end  and  aim  of  being.  And,  as  in  a  game  again,  so  with 
life  generally,  the  social  situation  furnishes  much  of  the 
driving  power,  though  again  there  are  many  who  can  be- 
come intensely  interested  in  solitaire. 

The  basis  of  a  science  of  conduct  must  be  fixed  principles 
of  action,  enduring  and  stable  motives.  It  is  doubtful, 
however,  whether  this  is  fundamentally  the  character  of 
human  life.  What  men  want  is  not  so  much  to  get  things 


54  RISK,  UNCERTAINTY,  AND  PROFIT 

that  they  want  as  it  is  to  have  interesting  experiences. 
And  the  fact  seems  to  be  that  an  important  condition  of 
our  interest  in  things  is  an  element  of  the  unanticipated,  of 
novelty,  of  surprise.  We  must  beware  of  the  temptation  to 
judge  the  nature  of  our  conduct  by  the  way  in  which  we 
think  about  it.  To  think  about  it  is,  of  course,  to  rational- 
ize it,  at  least  to  "think"  in  the  scientific  sense,  which  has 
pretty  well  preempted  the  word.  Logical  thought  is  in- 
strumental in  character,  a  device  for  controlling  and  using 
the  environment.  It  is,  perhaps,  a  vice  of  Western  civiliza- 
tion that  the  habits  of  thought  which  condition  our  won- 
derful material  achievements  tend  to  be  carried  over  into 
the  sphere  of  our  personal  lives.  The  writer  ventures  to 
surmise  that  this  sort  of  thing  is  approaching,  if  it  has  not 
already  reached,  a  climax.  The  fever  of  achievement  in  an 
external  sense  which  now  dominates  our  attitude  toward 
life  may  be  expected  to  give  place  to  a  saner,  more  epi- 
curean view.  Men  will  think  more  in  terms  of  thought, 
beauty,  and  joy  for  their  own  sakes  and  less  in  terms  of 
what  things  are  good  for,  what  can  be  done  or  gotten  with 
them.1 

Economics,  as  we  have  observed  before,  is  the  science  of  a 
certain  form  of  organization  of  human  activities.  The  fact 
of  organization  still  further  limits  the  scope  of  the  dis- 
cussion to  the  rationalistic  view  of  activity  as  directed  to 
the  satisfaction  of  wants  conceived  as  given  and  permanent 

1  It  is  impossible  to  follow  out  this  line  of  thought  to  the  length  that 
its  importance  really  justifies.  Considerations  somewhat  along  the  line 
suggested  are  ably  put  forward  in  a  lecture  on  John  Rushin  as  an  Econ- 
omist, by  Patrick  Geddes  (The  Round  Table  Series);  also  by  Professor 
H.  W.  Stuart  in  his  essay  on  "The  Phases  of  the  Economic  Interest,"  in 
the  volume  by  Dewey  and  others  entitled  Creative  Intelligence.  Cf.  also 
Wesley  C.  Mitchell,  "Human  Behaviour  and  Economics,"  Quarterly 
Journal  of  Economics,  vol.  xxix,  pp.  1  ff. 

At  the  opposite  extreme  a  presentation  of  economics  uncritically  ration- 
alized and  devitalized  to  the  point  of  approximate  chemical  purity  may  be 
found  in  the  writings  of  Professor  T.  N.  Carver.  The  old  economists  em- 
ployed the  concept  of  an  economic  man  deliberately  and  intelligently;  for 
Carver  he  is  literally  the  man  in  the  street. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       55 

entities.  Conduct  itself  is  necessarily  forward-looking,  but 
organized  conduct  is  still  more  so.  Any  machinery  of  or- 
ganization implies  relatively  much  taking  thought,  since  it 
requires  time  for  its  development  and  time  for  its  operation. 
A  most  essential  feature  of  economic  organization  as  it 
exists  is  its  anticipation  of  the  wants  of  the  consumer 
over  a  long  and  ever  longer  period  of  production;  and 
this  anticipation  implies  stability  in  the  character  of  the 
wants  themselves. 

A  clear  view  of  what  we  are  doing  demands  special  em- 
phasis on  this  character  of  economic  theory  as  the  science 
of  a  system  of  organization.  Human  activity  might  be 
relatively  unorganized  or  it  might  be  organized  in  many 
different  ways.  History,  and  especially  modern  history,  is 
largely  the  story  of  progressive  organization  and  its  changes 
in  form.  Organization  is  nearly  synonymous  with  division 
of  labor.  In  organized  activity  individuals  perform  differ- 
ent tasks,  and  each  enjoys  the  fruits  of  the  labor  of  others. 
The  two  fundamental  problems  of  organization  are  the 
assignment  of  tasks  and  the  apportionment  of  rewards. 
In  unorganized  action  each  person  performs  all  the  tasks 
by  whose  performance  he  benefits,  and  his  reward  is  the 
immediate,  physical  benefit  of  his  own  work.  But  when 
men  work  together  some  machinery  must  be  provided  to 
give  each  his  special  work  and  to  determine  the  amount  of 
the  results  of  others'  effort  which  he  shall  obtain  and  the 
amount  of  his  own  product  which  he  shall  give  up  to 
others. 

Modern  industrial  society,  the  "existing  economic 
order,"  performs  this  twofold  task  chiefly  through  free 
agreement  and  voluntary  exchange  between  individuals 
themselves.  Economic  theory  is  the  analysis  of  this 
mechanism,  viewed  for  the  scientific  purpose  of  simplifica- 
tion as  the  only  form  of  human  relation.  Going  back  to 
mediaeval  times  or  to  the  American  frontier,  we  find  rel- 
atively little  joint  activity,  except  for  the  division  of  labor 


H*t 


Khl<JL>  » 


56  RISK,  UNCERTAINTY,  AND  PROFIT 

between  the  sexes  and  in  the  family.  Such  organization  as 
existed  for  war,  religion,  etc.,  was  not  along  free  exchange 
lines.  But  there  was  always  some  commerce  with  different 
regions,  and  this  has  always  been  worked  out  largely 
through  exchange.  As  time  passes  we  find  that  the  greatest 
change  is  in  the  development  of  organization,  and  espe- 
cially of  the  voluntary,  free  exchange  type,  though,  to  be 
sure,  the  functions  of  the  political  state  develop  also.  We 
can  imagine  that  industrial  progress  might  have  taken  a 
very  different  form.  The  problems  of  the  apportionment 
of  tasks  and  rewards  might  be  solved  for  a  complicated, 
technical  civilization  by  an  autocratic,  theocratic,  or  mili- 
taristic giving  of  orders  and  rationing  of  produce  in  which 
the  individual  would  have  no  voice  in  the  least  detail  either 
of  his  work  or  his  enjoyment.1  Or,  again,  we  might  have 
any  one  of  numerous  forms  of  democratic  socialism.  Some 
(the  anarchists)  have  imagined  that  organization  might  be 
carried  out  without  either  exchange  relations  or  a  central- 
ization of  authority,  simply  by  general  consent.  But  it  has 
been  and  is  done  principally  through  competitive  free 
agreement,  and  our  task  is  to  study  this  mechanism  and 
not  any  other.   (#<*y  ~*+~"  **«V(U  ^A  i.***!] 

The  first  essential  of  the  existing  system  is  that  it  solves 
its  two  fundamental  problems  together,  as  one.  It  is  individ- 
ualistic; it  apportions  tasks  through  the  apportionment  of 
rewards;  it  is  an  automatic  system,  in  which  the  interrela- 
tions of  individuals  are  determined  by  self-seeking  on  the 
part  of  each.  The  foundation  of  the  process  is  the  private 
ownership  of  productive  resources  —  a  synonym  for  indi- 
vidual freedom.  There  is  (as  we  shall  see  more  at  length  as 
we  proceed)  no  difference  in  principle  between  the  ownership 
of  one's  own  powers  and  the  ownership  of  other  productive 
resources.  The  essence  of  ownership  is  the  association  or 
union  of  these  two  facts:  (1)  control  of  the  agency,  and  (2) 

1  The  extinct  civilizations  of  Mexico,  and  especially  of  Peru,  are 
alleged  to  have  been  largely  of  this  character. 


ndi 
anl 
be  | 


THEORY  OF  CHOICE  AND  OF  EXCHANGE   57 

the  right  of  disposition  over  its  product.  Modern  society 
(on  the  economic  side)  is  organized  on  the  theory  that  the 
owners  of  productive  resources  will  find  their  best  use  and 
place  them  in  it,  because  in  that  way  they  can  procure  the 
largest  returns  for  themselves.  This  system,  therefore,  in- 
volves the  assumption  that  even  in  a  complex  organization 
the  separate  contribution  of  each  separate  productive 
agency  can  be  identified,  and  that  free  competitive  relations 
tend  to  impute  to  each  agency  its  specific  contribution  as 
its  reward  for  participation  in  productive  activity.  And 
to  the  extent  that  the  system  works  at  all,  that  we  have 
economic  order  and  not  chaos,  this  assumption  must^ 
justified. 

Trom  another  point  of  view  we  may  envisage  the  task  of 
organization  in  three  steps  or  stages : 

1.  Society  as  an  organized  entity  must  decide  the  rela- 
tive importance  of  different  lines  of  consumption  as  a  basis 
for  the  guidance  of  production.  Closely  connected  with 
this  task,  and  worked  out  together  with  it,  is  the  apportion- 
ment of  existing  stocks  of  goods,  the  product  of  past  in- 
dustry, in  the  satisfaction  of  existing  wants.  This  twofold 
problem  is  worked  out  in  the  consumption  goods  market 
from  day  to  day.  The  study  of  the  process  constitutes  the 
first  main  division  of  economic  science,  the  theory  of  mar- 
ket price. 

2.  Society  must  actually  organize  production.  Every 
available  productive  agency  is,  so  far  as  the  system  is 
successful,  to  be  assigned  to  that  task,  and  grouped  with 
others  in  that  way  which  will  enable  it  to  make  the  great- 
est possible  contribution  to  the  social  dividend  (of  goods 
equated  quantitatively  according  to  the  value  scale  estab- 
lished in  the  consumption  goods  market).  The  machinery 
for  the  direction  of  productive  resources  to  their  different 
uses  is  organized  in  the  market  for  productive  resources. 
The  study  of  its  workings  is  the  second  fundamental  divi- 
sion of  the  science.    It  falls  into  two  subdivisions,  short- 


58  RISK,  UNCERTAINTY,  AND  PROFIT 

time  distribution  theory  and  long-time  value  theory.1  For 
the  purpose  of  this  study  the  supplies  of  productive  re- 
sources must  be  taken  as  fixed,  as  well  as  the  demand  which 
they  are  to  satisfy.  Both  the  prices  of  consumption  goods 
and  the  distributive  shares  are  in  fact  much  affected  by 
the  third  general  problem  cutting  across  both  the  others. 

3.  At  the  same  time  that  society  is  employing  existing 
resources  to  satisfy  existing  wants  it  is  also  setting  aside  a 
portion  of  its  existing  resources  to  increase  the  supplies  of 
those  resources  themselves,  to  improve  the  effectiveness  of 
their  use  by  working  out  better  methods  of  production,  and 
to  increase  its  own  membership  in  numbers  and  quality  by 
providing  for  an  excess  of  births  over  deaths  and  through 
education  and  refinement.  There  is  thus  another  aspect  to 
the  problems  of  relative  importances  and  of  organization. 
Decision  must  be  made  as  to  how  much  of  society's  income 
is  to  be  diverted  from  present  consumption  and  to  be  used 
for  the  purpose  of  furthering  social  progress,  and  the  di- 
verted income  must  be  applied  to  this  purpose  as  effectively 
as  may  be.  The  first  part  of  the  problem  is  solved  in  the 
market  by  competition  between  present  goods  and  the 
prospective  fruits  of  theiHnvestment,  giving  rise  to  a  rate 
of  capitalization  or  of  interest;  and  the  second  part  is  solved 
by  competition  for  savings  between  different  opportunities 
for  their  use.2 

The  fact  that  theoretical  reasoning  must  take  a  large, 
long-run  view  of  life  leads  to  a  difficulty  in  the  treatment  of 
wants  which  has  been  the  source  of  much  confusion.  Our 

1  For  fuller  statement  see  below,  chapter  v. 

2  We  must  by  no  means  be  understood  to  assert  or  assume  that  these 
things  are  done  ideally  or  even  in  the  best  practicable  manner  by  the  free 
exchange  system  of  organization.  In  the  first  and  third  problems  in  par- 
ticular, the  formation  of  the  social  value  scale  and  the  use  of  resources  in 
furthering  progress,  its  methods  and  results,  are  open  to  severe  criticism. 
But  again  we  do  not  assert  that  there  is  any  better  method  or  solution 
practically  available.  It  is  our  business  simply  to  analyze  and  describe  the 
workings  of  a  purely  voluntary,  individualistic,  competitive  system  in 
relation  to  the  fundamental  tasks  of  ojganization. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       59 

wants  have  the  character  of  intermittence  and  recurrence; 
in  any  short  period  of  time  they  are  satisfied  with  a  rela- 
tively small  amount  of  what  the  want  calls  for,  and  we 
turn  to  the  satisfaction  of  some  other  want.  But  if  it  is 
a  true  fundamental  want  it  comes  back  again,  and  from 
a  long-run  point  of  view  they  all,  with  their  satisfactions, 
take  on  the  character  of  continuity.  The  periodicity,  al- 
ternation between  desire  and  satisfaction  in  the  case  of  any 
one  and  dominance  of  different  wants  in  succession,  drops 
out  if  we  look  ahead  a  considerable  distance  so  as  to  in- 
clude a  number  of  "complete  cycles,"  so  to  speak.  This 
long-run  point  of  view  is  the  one  necessarily  taken  by  a 
planned  program  of  satisfying  wants;  it  is  evident  that  our 
activities  at  a  moment  are  not  predominantly  affected  by 
the  thing  we  happen  to  be  "hungry"  for  at  that  moment. 
When  we  go  into  a  store  to  make  our  purchases  we  do  not 
consult  the  momentary  state  of  appetite  or  satiety  in  re- 
spect of  any  particular  need,  but  its  long-run  importance 
in  our  existence  viewed  as  a  continuous  process. 

The  problem  of  want-satisfaction  is,  therefore,  a  problem 
in  'proportions,  or  relative  rates.  The  question  is  not  how 
much  absolutely  of  this  or  that,  but  how  much  —  i.e.,  how 
large  a  share  —  of  our  time  or  income  is  to  be  devoted  to 
each  need  or  line  of  activity,  how  much  per  year  or  some 
other  period  long  enough  to  get  rid  of  the  fluctuations. 
We  can  get  the  point  of  view  by  imagining  that  we  had  to 
plan  our  lives  for  a  year  on  the  first  of  January  and  live  out 
the  plan  in  detail.  Economic  discussion  in  terms  of  "  quan- 
tities" of  effort  or  satisfaction  or  choice  between  alterna- 
tives, under  the  influence  of  motives  as  immediate  desires, 
is  therefore  elliptical,  and  more  or  less  dangerous.  The 
quantities  of  economics  are  properly  rates,  the  motives  not 
desires  immediately  present  to  consciousness,  but  detached 
judgments  of  need  or  value. 

A  fundamental  fact  about  wants  is  their  habit  of  con- 
flicting among  themselves.   In  fact,  conflict  seems  to  be 


60  RISK,  UNCERTAINTY,  AND  PROFIT 

essential  to  the  very  nature  of  conscious  desire.  It  is 
questionable  whether  wants,  as  conscious  motives  to  con- 
duct, ever  exist  unless  we  are  in  a  position  of  having  to 
choose,  to  adopt  one  line  of  conduct  and  renounce  another. 
Wants  must  be  distinguished  from  needs  which  do  not  enter 
into  our  planful  ordering  of  life.  We  "need"  iodides  and 
vitamines,  and  an  infinite  number  of  things  of  whose  exist- 
ence the  race  at  large  has  been  blissfully  ignorant;  but  we 
do  not  "want"  them,  because  they  give  rise  to  no  con- 
flicts and  hence  no  "conduct."  The  common  basis  of  con- 
flict, and  we  may  say  of  the  existence  of  wants  at  all,  is  the 
limitation  in  the  means  of  gratifying  some  impulse  or  need. 
When  some  means  of  satisfaction  is  limited  in  amount  so  that 
we  have  to  plan  its  use  and  plan  to  increase  its  supply, 
then  it  enters  into  the  field  of  conduct  and  we  have  a  want. 
The  most  common  and  fundamental  conflicts  are  between  i 
claims  for  our  own  time  -and  energy,  and  after  these  upon 
some  limited  material  agency  or  means  employed  as  an  aid 
in  satisfying  ourselves.  Our  personal  powers  are,  of  course, 
limited  absolutely,  and  limited  in  fact  still  further,  con- 
ditionally, by  the  tendency  of  exertion  to  become  disagree- 
able, giving  rise  to  a  "want"  to  avoid  it.1  The  confusion 
to  be  avoided  is  that  between  a  want,  proper,  as  related  to 
consciously  planned  action,  the  weighing  of  alternatives, 
and  such  things  as  supposed  needs  or  metaphysical  ex- 
planations of  the  immediate  fact. 

1  It  is  outside  our  purpose  to  attempt  a  detailed  classification  of  wants. 
We  may  notice  in  passing  the  difficulty  of  distinguishing  between  really 
different  wants  and  different  means  of  satisfying  the  same  want.  For 
example,  we  may  speak  of  the  want  for  food,  or  wants  for  different  foods; 
one  can  supply  the  place  of  another  within  limits,  but  only  within  limits, 
and  finally  the  desire  for  variety  itself  becomes  a  want.  In  our  view 
wants  must  be  classified  for  the  purposes  of  economic  science  in  accordance 
with  the  actual  market  classification  of  goods.  Nor  shall  we  pretend  to  go 
into  the  psychological  problem  of  the  basis  of  desire.  Our  discussion  deals 
with  things  in  relation  to  conduct,  and  it  is  a  matter  of  no  concern 
whether  we  want  the  things  or  the  conscious  states  we  expect  to  derive 
from  them,  or  what,  so  long  as  the  relation  between  the  acts  themselves 
and  the  material  changes  toward  which  they  are  directed  is  clear. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       61 

The  power  of  things  to  satisfy  conscious  wants,  or 
quality  of  being  wanted,  is  utility  in  the  economic  sense, 
which  is  equivalent  to  "power  over  conduct."  Utility,  of 
course,  must  have  the  same  fundamental  properties  or 
dimensions  as  want;  it  is  not,  therefore,  a  quantity  in  any 
simple  sense,  but  a  quality  having  intensity,  or  a  rate.  We 
speak  of  the  utility  of  a  given  amount  of  a  thing,  but  this 
again  is  elliptical;  the  psychological  variable  is  in  fact  a 
degree  of  utility  of  a  certain  rate  of  consumption  of  the 
good.  And  as  want  is  a  correlate  of  conflict,  utility  is  a 
correlate  of  limitation;  intensity  of  want  and  rate  of  supply 
of  means  of  satisfying  it  are  strictly  connected,  each  vary- 
ing inversely  as  the  other;  that  is  to  say,  as  a  good  is  sup- 
plied for  the  satisfaction  of  any  want  at  higher  rates  it 
loses  degree  or  intensity  of  utility  in  that  use  and  gains 
(degree  of)  utility  in  the  conflicting  employment.1  The 
confusion  between  a  want  and  a  need  or  hypothetical 
reason  for  having  the  want  is  manifest  in  the  field  of 
utility  in  ascribing  economic  utility  to  "free"  goods,  goods 
that  exist  in  superabundance.  This  is  a  pernicious  error. 
Such  goods  have  no  causal  relation  to  conduct  and  no 
place  in  a  science  of  conduct.  The  confusion  has  doubtless 
arisen  from  the  fact  that  there  are  many  things  like  air  and 
water  which  under  some  circumstances  do  come  to  have 
power  over  conduct,  or  utility,  though  ordinarily  they  do 
not.  This  fact  brings  home  to  our  consciousness  their 
"potential"  utility,  the  fact  that  they  would  have  great 
utility  if  cut  off  or  subject  to  limitation;  but  they  have 
utility  only  when  not  free. 

1  There  seem  to  be  and  perhaps  are  exceptional  cases  where  this  de- 
scription does  not  fit  the  facts;  there  seem  to  be,  that  is,  absolute  wants, 
based  on  absolute  limitation  and  not  on  limitation  due  to  conflicting 
demand  for  the  means  of  satisfaction.  These  are  certainly  of  negligible  im- 
portance in  economics,  however,  and  on  scrutiny  they  have  a  tendency  to 
lose  the  character  of  "wants"  altogether.  It  is  hard  to  see  how  a  science 
can  deal  fruitfully  in  a  constructive  way  with  utterly  capricious  phenom- 
ena; of  course  it  must  deal  with  them  in  the  sense  of  recognizing  that 
they  exist  and  form  a  limitation  on  the  completeness  of  theory,  but  they 
can  hardly  be  taken  account  of  in  the  theory  itself. 


62  RISK,  UNCERTAINTY,  AND  PROFIT 

/  Diminishing  utility  is  the  scientific  designation  for  the 
general  fact  that  as  any  want  is  satisfied  relatively  to 
others  x  it  diminishes  in  intensity,  or,  from  the  point  of 
view  of  the  means  of  satisfaction,  that  the  one  loses  in 
utility  and  the  other  gains.  The  essential  relation  of  con- 
flict and  relativity  of  utilities  is  somewhat  obscured  by  the 
existence  of  intermediate  "means"  of  satisfaction,  and  even 
of  series  of  such.  But  the  further  course  of  the  analysis 
will  show  that  without  significant  exception  there  is  always 
in  question  a  diversion  of  the  ultimate  means  from  one  use 
to  another;  it  is  a  matter  of  alternatives,  and  the  ground  of 
one  want  or  satisfaction  being  alternative  to  another  is  the 
r  dependence  on  a  common,  limited  means  of  satisfaction. 

The  intermittence  of  wants,  with  wave-like  alternation 
of  desire  and  satisfaction,  tends  to  give  a  false  conception 
of  diminishing  utility.  It  is  beside  the  point  to  talk  of 
boys  eating  successive  oranges  or  other  "dinner-table" 
illustrations  as  is  so  commonly  done.  The  serious  error 
resulting  from  this  method  is  that  it  gives  the  impression 
that  there  is  a  difference  between  the  utilities  of  different 
portions  of  supply.  This  also  is  fatal  to  clear  thinking,  as 
will  be  seen  if  the  contrast  between  such  a  situation  and 
that  of  laying  in  supplies  for  a  long  time  in  advance  (or 
even  an  ordinary  shopping  trip)  is  considered  for  a  mo- 
ment. The  utility  of  any  one  unit  is,  in  its  effect  on  con- 
duct, which  is  the  only  relevant  consideration,  exactly 
like  that  of  any  other;  the  essential  fact  is  that  as  there 
are  more  units  relatively,  the  utility  per  unit  or  utility  of 
any  unit  is  relatively  less. 

1  We  carry  some  wants  to  complete  satiety  because  it  takes  less  effort 
than  would  be  required  to  calculate  accurately  the  most  desirable  place 
to  stop  when  this  point  would  be  near  the  absolute  satiety  limit,  as  in  the 
case  of  eating  bread,  for  example.  The  fact  may  serve  to  illustrate  the 
fundamental  "irrationality"  of  a  perfectly  "rational"  attitude  to  life. 
One  of  our  most  significant  "wants"  is  freedom  from  the  bother  of  cal- 
culating things  or  making  close  estimates.  Cf .  J.  M.  Clark,  "  Economics 
and  Modern  Psychology,"  Journal  of  Political  Economy,  vol.  26,  nos. 
1  and  2. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE      63 

The  fact  of  relativity  is  important,  because  easily  and 
commonly  lost  sight  of.  Every  valuation  is  a  comparison;  < 
we  have  no  conception  of  an  absolute  utility  or  an  absolute 
standard  of  utility.  The  notion  of  value  is  meaningless 
except  in  relation  to  alternatives  of  choice.  Not  only  is 
utility  measured  by  another  utility,  —  all  things  are 
measured  by  things  of  their  own  kind  as  standards,  — 
but  its  existence  is  conditioned  by  that  of  the  alternative;  it 
is  like  a  force  in  the  physical  world;  action  and  reaction  are 
equal,  a  force  cannot  be  imagined  separate  from  an  equal 
and  opposite  force  or  resistance. 

The  case  of  conflict  of  utilities  most  crucial  in  economic 
analysis  is  the  familiar  alternative  of  enjoying  utilities  at 
the  expense  of  effort  vs.  sacrificing  the  utility  for  the  sake  of 
freedom  from  the  exertion.  "Labor"  is  usually  thought  of 
in  an  inverted,  positive  sense  as  a  disutility.  It  is  im- 
portant to  see  that  there  is  sufficient  practical  reason  for 
this  usage,  but  also  that  there  is  really  no  exception  to 
the  general  principle  of  alternatives  without  distinction  of 
kind.cThe  point  is  that  "labor"  is  really  the  sacrifice  of 
some  desirable  alternative  use  of  one's  time  and  strength. 
.rlf  there  is  no  alternative  there  is  no  sacrifice,  nor  any 
motivation,  valuation,  or  "problem"  of  any  kind.  In 
truth,  there  is  no  distinction  for  conduct  between  a  pain 
and  the  absence  of  a  pleasure;  it  is  all  a  matter  of  choice 
between  alternatives,  of  "preference."  The  pleasure-pain 
question  belongs  exclusively  in  the  field  of  the  inner  con- 
sciousness, and  has  no  bearing  on  problems  such  as  those 
of  economics.1  ;:The  valid  reason  for  the  distinction  between 

1  Even  "for  consciousness"  the  difference  between  pleasure  and  the 
absence  of  pain  and  conversely,  though  real,  is  of  an  "accidental"  and 
very  elusive  character;  we  cannot  formulate  a  difference  between  the  two 
series  or  classify  experiences  between  them.  It  is  too  obvious  to  call  for 
discussion  that  the  same  event  will  be  a  pleasure  to  one  person  and  a  pain 
to  another,  and  even  pleasurable  to  the  same  person  at  one  time  and  pain- 
ful at  another,  according  to  circumstances,  and,  especially,  expectations. 
The  difference  fades  out  on  scrutiny.  An  inheritance  of  a  hundred  thou- 
sand, which  is  a  pleasure  to  one  to  whom  it  is  a  surprise,  may  be  an  in- 


64  RISK,  UNCERTAINTY,  AND  PROFIT 

kinds  of  alternatives,  for  fixing  our  attention  on  something 
chosen  in  one  case  and  something  avoided  in  another,  is, 
as  will  be  shown  more  at  length  later  on,  that  we  are  inter- 
ested in  measuring  the  alternatives,  and  we  can  come  nearer 
a  satisfactory  quantitative  determination  of  time  and 
effort  than  we  can  of  the  indeterminate  uses  that  would 
have  been  made  of  them  if  the  labor  of  producing  the 
(measurable  quantity  of)  goods  had  not  been  performed. 

The  whole  theory  of  conduct  may  now  be  summed  up, 
as  far  as  it  is  relevant  for  our  purposes,  in  a  comprehensive 
Law  of  Choice":  When  confronted  with  alternative,  quanti- 
tatively variable  lines  of  action  or  experience,  we  tend  to  com- 
bine them  in  such  proportions  that  the  physically  correlated 
amounts  or  degrees  of  each  are  of  equal  utility  to  the  person 
\  choosing.1 

tense  grief  if  he  has  expected  and  made  his  plans  for  ten  million.  A  prison 
sentence  is  undoubtedly  a  source  of  joy  to  a  man  who  counted  on  being 
hanged,  and  it  is  ridiculous  to  say  that  it  is  "really"  only  an  escape  from  a 
worse  pain,  or  the  inheritance  a  deprivation  of  a  greater  pleasure.  The 
comparison  of  alternatives  and  fact  of  preference  is  the  real  thing;  pleas- 
ure and  pain  are  accidental  and  arbitrary  matters. 

1  The  phrase  "equal  utility,"  as  we  shall  presently  see,  should  be 
taken  to  refer  merely  to  the  fact  of  indifference  in  choice,  and  not  a  com- 
parison between  quantities  in  the  true  sense  at  all.  We  avoid  the  expres- 
sion "marginal "  utility,  because  of  its  implication  that  there  is  a  difference 
in  the  significance  of  different  portions  of  the  same  supply.  In  speaking  of 
the  utility  of  a  supply,  however,  it  is  sometimes  useful  to  have  some  word 
to  distinguish  between  the  utility  per  unit  and  the  utility  of  the  supply 
as  a  whole.  When  it  seems  advisable  we  shall  use  the  expression  "  specific 
utility"  to  indicate  utility  per  unit. 

The  general  method  of  taking  the  principle  of  choice  as  the  starting- 
point  of  economic  reasoning  and  treating  "diminishing  utility"  in  a  com- 
parative sense  has  been  used  with  especial  clearness  and  force  by  Wick- 
steed  {Common  Sense  of  Political  Economy),  and  is  also  adopted  by  Fetter 
in  his  recent  work  {Economic  Principles).  Economists  generally  have  been 
coming  to  recognize  that  the  psychology  of  the  subject  is  properly  be- 
havioristic;  that  an  economist  need  not  be  a  hedonist  (Jevons  and  Edge- 
worth  notwithstanding),  and  that  he  does  not  need  even  to  consider  the 
issue  between  rival  psychologies  of  choice.  See  Mitchell,  "The  Role  of 
Money  in  Economic  Theory,"  Proceedings,  Twenty-Eighth  Annual  Meet- 
ing of  the  American  Economic  Association.  The  principle  of  relativity  of 
utility  and  value  holds  in  the  same  way  under  any  theory  of  motivation. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       65 

A  somewhat  different  statement  of  the  principle  of 
choice  may  better  emphasize  the  basis  of  the  alternative 
character  of  the  alternative  lines  of  conduct,  the  fact  that 
not  only  must  one  give  up  more  of  the  one  to  get  more  of 
the  other,  but  that  this  is  true  in  a  quantitative  sense, 
that  a  definite  amount  of  one  is  given  up  in  return  for  a 
definite  amount  of  the  other.  The  reason  for  this  fact  we 
have  found  in  the  circumstance  that  the  two  kinds  of  satis- 
faction are  both  dependent  on  some  common  "means" 
or  "resource."  Accordingly  we  may  restate  the  funda- 
mental law  of  conduct  in  this  way:  In  the  utilization  of 
limited  resources  in  competing  fields  of  employment,  which  is 
the  form  of  all  rational  activity  in  conduct,  we  tend  to  ap- 
portion our  resources  among  the  alternative  uses  that  are  open 
in  such  a  way  that  equal  amounts  of  resource  yield  equivalent 
returns  in  all  the  fields.  ; 

This  formulation  makes  it  possibly  a  little  more  obvious 
that  the  principle  is  a  true  statement  of  the  goal  of  rational 
planning.  For,  clearly,  if  a  given  unit  of  a  given  resource 
is  yielding  in  one  use  a  want  satisfaction  preferable  to  that 
which  a  similar  unit  is  yielding  in  another,  the  yield  of  that 
resource  can  be  increased  by  transferring  some  of  it  from 
the  second  use  to  the  first  until  the  importance  of  the  one  is 
increased  and  of  the  other  decreased  to  the  point  of  equiva- 
lence.1 

B.  M.  Anderson,  Jr.  (Social  Value,  and  Value  of  Money,  chap,  i)  advocates 
a  theory  of  absolute  social  value,  defining  value,  as  we  have  done,  as  power 
to  motivate  conduct.  It  is  hard  to  explain  his  failure  to  see  that  this 
notion  is  as  relative  as  any  other,  is  in  fact  the  most  obviously  relative  of 
all.  Motivation  of  conduct  means  of  "this"  conduct  rather  than  some 
other,  and  is  obviously  inconceivable  apart  from  a  situation  presenting 
alternatives  between  which  comparison  and  choice  must  be  made. 
Davenport,  also  (Economics  of  Enterprise,  chap,  vii),  while  insisting  on 
the  importance  of  relative  utility  in  economic  reasoning,  treats  utility 
itself  as  an  absolute  magnitude.  The  present  writer  finds  it  impossible 
to  conceive  such  an  entity. 

1  Close  scrutiny  makes  it  appear  doubtful  just  how  much  real  ex- 
planatory value  the  viewpoint  of  the  utilization  of  resources  adds  to  the 
bare  principle  of  combining  alternatives.   It  seems  that  what  we  call  a 


66  RISK,  UNCERTAINTY,  AND  PROFIT 

It  will  be  apparent  that  utility  curves,  as  commonly 
drawn,  representing  diminishing  utility  and  increasing 
sacrifice  as  absolute  and  independent  magnitudes,  and  as- 
cribing varying  utility  to  successive  units  of  commodities 
(and  of  disutility  of  exertion),  require  considerable  modi- 
fication or  reinterpretation  if  the  foregoing  reasoning  is 
valid.  If  utility  is  relative  and  in  its  essence  a  comparison, 
such  a  curve  can  only  represent  one  variable  measured  in 
terms  of  the  other,  or  each  curve  presupposes  the  other 
already  drawn.  The  role  of  money  in  the  process  tends 
to  complicate  and  confuse  the  exposition  still  further. 
w^The  principles  above  stated  in  general  terms  can  be 
brought  into  relation  with  current  treatments  of  the  sub- 
ject and  with  concrete  fact  if  we  begin  by  taking  up  a 
simple  case  of  choice  between  alternatives  such  as  is  con- 
stantly dealt  with  in  economic  analysis.  Let  us  take  Mar- 
shall's 1  example  of  a  boy  gathering  and  eating  berries,  but 
with  the  stipulation  that  some  re-wording  would  be  neces- 
sary to  make  the  exposition  accurately  fit  the  case  of 
choice  between  (i.e.,  combination  of)  alternatives  in  a  com- 
prehensive, long-time,  plan  of  conduct.  We  can  hardly 
suppose  that  the  boy  goes  through  such  mental  operations 
as  drawing  curves  or  making  estimates  of  utility  and  dis- 
utility scales.    What  he  does,  in  so  far  as  he  deliberates 

"resource"  is  such,  not  on  its  own  account,  but  solely  because  of  the  uses 
to  which  it  can  be  put,  and  its  quantitative  aspect,  how  much  resource 
there  is,  is  still  more  evidently  determinable  only  in  terms  of  the  use. 
But  at  least  the  resource  idea  helps  us  to  mediate  in  thought  the  fact  of 
the  quantitatively  alternative  character  of  the  opposed  lines  of  utilization, 
as  is  shown  by  the  fact  that  we  habitually  make  use  of  it.  The  form  of  the 
unsophisticated  psychosis  in  regard  to  sacrifices  or  "costs"  is  in  fact  a 
bit  puzzling.  If  we  ask  what  a  thing  has  cost,  we  seem  inclined  to  answer 
first  in  terms  of  money  or  effort,  etc.,  i.e.,  of  "resources  " ;  but  when  pressed, 
we  are  likely  to  go  back  of  the  latter  and  evaluate  the  resource  in  turn  in 
tefms  of  some  other  utility  which  might  have  been  had  for  it.  The  "on- 
tologizing"  of  the  notion  of  resources  seems  to  be  an  illustration  of  an 
"instrumental  concept,"  but  one  which  it  would  be  difficult  to  get  along 
without. 

1  Principles  of  Economics,  book  v,  chap,  n,  sec.  1. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       67 

between  the  alternatives  at  all,1  is  to  consider  together, 
with  reference  to  successive  amounts  of  his  "commodity," 
the  utility  of  each  increment  against  its  "cost  in  effort," 
and  evaluate  the  net  result  as  either  positive  or  negative, 
either  of  a  character  to  prompt  the  combined  action  of 
production  and  consumption  of  that  unit,  or  not  of  this 
character.  The  "cost  in  effort"  is  evidently  in  fact  the 
sacrifice  of  some  alternative  use  or  uses  of  the  effort.  Even 
that  nondescript  conduct  called  merely  idling  is  still  con- 
duct, an  alternative  motive,  and  subject  to  the  law  of 
diminishing  utility  or  relative  proportions  like  any  other. 
However,  while  to  the  eye  of  critical  scrutiny  there  is  no 
"logical"  distinction  between  an  increasing  disutility  ex- 
perienced and  an  increasing  utility  foregone,  a  "psycho- 
logical" difference  must  be  admitted;  there  is  no  difference 
for  conduct,  but  there  is  one  for  consciousness,  to  our 
pecuniarily  sophisticated  consciousness  at  least. 

If  it  is  desired  to  represent  the  situation  graphically 
without  the  misleading  implications  of  a  comparison  of 
separate  absolute  variables,  it  can  be  done  by  omitting  the 
commodity  axis  as  in  the  accompanying  figure.  The  line 
OY  is  merely  directed  in  space  to  show  that  "preference" 
increases  in  a  vertical  direction.  Quantities  of  commodity 
are  measured  by  a  scale  as  shown,  but  the  "utilities"  are 
not  fitted  to  any  scale  at  all.  If  we  call  the  curve  U  which 
represents  the  desirability  of  the  commodity,  and  the 

1  Which,  to  be  sure,  is  not  very  far.  Nor  is  this  any  criticism  of  the 
boy.  Quite  the  contrary !  It  is  evident  that  the  rational  thing  to  do  is  to 
be  irrational,  where  deliberation  and  estimation  cost  more  than  they  are 
worth.  That  this  is  very  often  true,  and  that  men  still  oftener  (perhaps) 
behave  as  if  it  were,  does  not  vitiate  economic  reasoning  to  the  extent 
that  might  be  supposed.  For  these  irrationalities  (whether  rational  or 
irrational!)  tend  to  offset  each  other.  The  applicability  of  the  general 
"theory"  of  conduct  to  a  particular  individual  in  a  particular  case  is 
likely  to  give  results  bordering  on  the  grotesque,  but  en  masse  and  in 
the  long  run  it  is  not  so.  The  market  behaves  as  if  men  were  wont  to 
calculate  with  the  utmost  precision  in  making  their  choices.  We  live 
largely,  of  necessity,  by  rule  and  blindly;  but  the  results  approximate 
rationality  fairly  well  on  an  average. 


68 


RISK,  UNCERTAINTY,  AND  PROFIT 


other  E  for  exertion,  the  one  will  show  a  (relative)  fall  in 

value  and  the  other  a  (rela- 
tive) rise  as  the  production 
and  consumption  of  the 
commodity  increases.  It  is 
a  matter  of  indifference 
whether  the  ascending  curve 
is  thought  of  as  a  sacrifice 
or  a  positive  pain,  whether 
the  growing  motive  to  di- 
vert energy  from  the  use  in 
question  is  imaged  as  an 
attraction  or  a  repulsion. 
The  intersection  shows  that 
at  a  certain  point  (on  the  commodity  scale)  the  diversion 
will  take  place. 

Beyond  this  point  the  curves  have  still  less  meaning 
for  the  reason  that  the  E  curve  really  represents  nothing 
definite,  but  merely  any  alternative  whatever;  as  drawn 
they  indicate  a  rapidly  increasing  pressure  against  this 
particular  line  of  activity.  The  curves  indicate  no  absolute 
values  of  any  sort;  the  vertical  distance  between  them  alone 
has  meaning,  each  being  the  "base"  for  the  other;  this 
distance  shows  what  might  be  called  the  "net  utility"  of 
picking  and  eating  the  successive  increments  of  berries,  as 
compared  with  all  possible  alternatives  of  conduct. 

A  still  simpler  and  less  ambiguous  way  to  represent  the 
facts  would  be  to  draw  on  a  Cartesian  plane  a  single  curve 
of  "net  utility,"  as  in  the  accompanying  sketch.  This 
curve  will  cut  the  X  or  commodity  axis  at  the  point  where 
some  other  alternative  becomes  preferable,  and  then  fall 
away  rapidly  into  the  "negative  utility"  field.  It  will  be 
seen  that  the  Y  values  of  the  curve  have  only  the  vaguest 
quantitative  character.  The  boy  not  only  does  not  ask 
how  much  sacrifice  is  how  many  berries  worth,  but  merely, 
are  these  berries  worth  the  sacrifice;  he  does  not  even  ask, 


THEORY  OF  CHOICE  AND  OF  EXCHANGE 


"by  how  much**  are  these  berries  worth  "the"  sacrifice. 
There  is  no  true  psychic 
quantity  involved;  only 
the  commodity  is  meas- 
ured or  measurable.  Still, 
there  is  a  certain  feeling 
of  quantitative  variability 
in  the  degree  of  prefer- 
ence, and  such  a  curve  is 
not  utterly  false  to  the 
facts  of  consciousness.  The 
only  point  of  clearly  de- 
terminate locus  on  the 
curve  is  the  zero  point,  and 
it  is  questionable  whether  that  is  to  be  interpreted  as  a 
quantitative  equality  between  opposite  incentives  to  ac- 
tion or  merely  the  absence  of  incentive  altogether.1 

It  follows  at  once  from  the  non-quantitative  or  indefi- 
nitely quantitative  character  of  the  psychic  variables2 

1  The  discussion  assumes  that  the  quantitative  relation  between  the 
alternatives  themselves  remains  unchanged,  that  one  is  sacrificed  for  the 
other  in  the  same  ratio  throughout,  or  "resources"  converted  into  both  at 
the  same  rate.  In  practice  this  is  only  exceptionally  possible;  in  general 
not  only  the  relative  importance  of  given  quantities  of  alternative  goods 
will  change  as  the  supply  changes,  but  in  addition  the  amount  of  one  which 
must  be  sacrificed  to  obtain  a  given  amount  of  the  other  will  increase  as 
the  supply  of  the  first  increases;  i.e.,  a  "law  of  diminishing  productivity" 
(likewise  a  law  of  proportions  merely)  becomes  operative  in  addition  to 
the  law  of  diminishing  utility  (and  works  in  the  same  direction). 

Professor  Patten  has  raised  the  objection  to  the  utility  analysis  that 
consumption  also  requires  time,  which  must  be  saved  out  of  the  pro- 
ductive operations.  (See  Annals,  Amer.  Acad.  1892-93,  pp.  726-28.  Cf. 
also  Edgeworth,  Mathematical  Psychics,  p.  68,  where  the  energy  as  well  as 
time  required  for  consumption  is  considered.)  It  seems  logically  more 
accurate,  however,  to  include  in  production  everything  except  the  actual 
experience  of  satisfaction,  and  if  this  is  done  the  objection  loses  its  force. 
In  our  method  of  approach  to  the  problem,  viewing  it  as  a  matter  of 
choice  between  (i.e.,  combination  of)  alternatives,  and  taking  the  al- 
ternatives simply  for  whatever  they  may  be  in  the  facts  of  the  case,  the 
whole  issue  loses  its  relevance. 

2  This  may  be  expressed  in  technical  phrase  by  saying  that  they  are 


70  RISK,  UNCERTAINTY,  AND  PROFIT 

that  the  "surpluses"  which  have  cut  so  much  figure  in  eco- 
nomic discussion  are  very  shadowy  and  elusive  things,  if 
not  altogether  unreal.  If  the  ordinates  of  the  curves  dis- 
cussed above  mean  nothing  definite,  of  course  the  areas 
under  the  curves  mean  no  more.  The  fallacious  notion  of 
the  surplus  follows  naturally  from  the  confusion  between 
momentary  satiety  and  the  correct  standpoint,  the  estima- 
tion of  relative  importance  of  things  in  planning  ahead, 
commented  on  above.  The  illicit  use  of  "dinner- table" 
illustrations  in  the  exposition  of  diminishing  utility  shows 
the  same  error.  We  cannot  insist  too  strongly  upon  the 
point  that  men  do  not  determine  the  expenditure  of  their 
income,  generally  speaking,  on  the  basis  of  a  comparison  of 
momentary  cravings  for  things  for  instantaneous  consump- 
tion. A  child  in  a  candy  store  would  not  do  that.  From 
such  a  viewpoint  there  is  a  psychic  difference  in  different 
units  of  a  commodity,  and  it  might  be  possible  to  sub- 
stantiate a  surplus  doctrine.  But  this  is  not  the  view- 
point of  economic  reasoning,  because  in  so  far  as  men  plan 
at  all,  they  do  not  expend  their  incomes  and  so  fix  the 
prices  of  things  and  determine  the  utilization  of  social  re- 
sources and  the  whole  structure  of  the  competitive  eco- 

" ordinal"  rather  than  "quantitative";  they  are  variable,  but  not  meas- 
urable, can  be  ranked,  but  not  added.  The  nature  of  this  attribute  will  lose 
its  mystery  if  any  simple  sensation,  as  a  sensation,  is  considered  for  a 
moment.  It  is  easy  to  tell  when  one  light  is  brighter  than  another,  im- 
possible to  tell  how  much  brighter.  The  intensity  of  light  is  indeed 
"measured"  by  science,  but  it  is  done  by  a  method  analogous  in  principle 
to  the  discussion  of  utility  above.  One  light  is  removed  to  such  a  distance 
that  it  becomes  equal  in  intensity  to  the  standard,  and  the  distance  is 
measured.  Obviously  this  does  not  involve  the  measurement  of  sensation 
at  all.  Similarly,  a  thermometer  does  not  measure  the  sensation  of  heat,  or 
a  balance  that  of  weight.  A  better  illustration  of  "ordinal"  variables  is 
furnished  by  the  field  of  aesthetics  (another  form  of  "value,"  of  course). 
We  can  tell  that  one  poem  or  picture  is  better  than  another,  but  no  one 
would  seriously  propose  measuring  the  superiority.  To  be  sure,  in  school 
and  in  contests  we  may  go  through  the  motion  of  "grading"  such  things 
(even  deportment !)  on  a  percentage  scale,  but  no  one  whose  opinion  is 
entitled  to  respect  attaches  any  particular  weight  to  the  results  of  this 
make-believe. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       71 

nomic  system,  on  the  basis  of  that  sort  of  calculation.1 
If  we  take  a  rational  attitude  toward  the  problem  of  value 
—  as,  for  example,  by  the  device,  previously  suggested,  of 
placing  ourselves  in  the  position  of  one  who  had  to  deter- 
mine the  apportionment  of  his  resources  for  a  year  or  five 
years  in  advance  —  we  shall  get  a  different  view  of  it.  Then 
the  earlier  units  are  no  different  from  the  later  ones,  on 
either  side  of  the  balance;  up  to  a  certain  point  the  balance 
is  positive,  then  it  suddenly  becomes  negative,  and  when 
the  balance  is  struck  the  debits  and  credits  are  equal. 
There  is  a  sort  of  Emersonian  principle  of  Compensation 
applicable  to  every  item;  each  is  worth  what  it  costs,  but 
also  costs  what  it  is  worth. 

It  does  not  at  all  follow  that  we  have  proved  the  pleasures 
of  life  just  equal  to  its  pains.  That  question  is  irrelevant  to 
our  problems,  and  our  analysis  has  nothing  to  say  about  it. 
It  is  not  the  province  of  economics  to  determine  the  value 
of  life  in  "hedonic  units"  or  any  other  units,  but  to  work 
out,  on  the  basis  of  the  general  principles  of  conduct  and 
the  fundamental  facts  of  the  social  situation,  the  laws 
which  determine  the  prices  of  commodities  and  the  di- 
rection of  the  social  economic  process.2  It  is  therefore  not 

1  That  to  a  considerable  extent  purchases  are  based  on  momentary 
impulse  and  not  on  an  estimaticr-  of  relative  long-time  significance,  is, 
of  course,  true,  and  perhaps  increasingly  so  with  the  development  of  the 
"anti-social"  arts  of  window-dressing,  display  advertising,  and  salesman- 
ship. This  is  one  of  the  important  "allowances"  that  has  to  be  made  in 
applying  economic  theory  to  actual  fact,  until  the  progress  of  the  science 
reduces  the  phenomena  to  general  laws  and  incorporates  them  into  the 
deductive  system.  (Cf.  above,  p.  52,  and  note;  also  p.  61,  note.)  Effects 
balance  out  to  approximate  rationality  under  the  law  of  large  numbers. 

2  The  doctrine  of  the  surplus  is  one  of  the  few  points  where  the  writer 
is  compelled  to  disagree  with  Marshall  on  a  fundamental  matter  of  doc- 
trine. (See  Principles,  6th  ed.,  pp.  125-33,  esp.  p.  129,  note.)  The  ques- 
tion relates  to  "scope  and  method,"  however,  rather  than  to  fact  or  logic. 
I  simply  cannot  see  any  use  for  the  notion  in  understanding  human  con- 
duct or  explaining  economic  phenomena,  and  am  convinced  that  the  con- 
fusion of  viewpoint  which  underlies  putting  it  to  the  fore  has  led  to  serious 
error  and  the  drawing  of  wholly  irrelevant  conclusions  from  economic 
reasoning.    Moreover,  an  appeal  to  "unsophisticated  common  sense" 


72  RISK,  UNCERTAINTY,  AND  PROFIT 

quantities,  nor  even  intensities,  of  satisfaction  with  which 
we  are  concerned  (though  the  limitations  of  language  com- 
pel the  use  of  these  terms  at  times),  or  any  absolute  magni- 
tude whatever,  but  the  purely  relative  judgment  of  com- 
parative significance  of  alternatives  open  to  choice.  Now, 
for  conducty  it  is  self-evident  that  the  importance  of  any- 
thing is  the  effort  or  sacrifice  necessary  to  get  it.  Two 
things,  each  of  which  can  be  obtained  at  will  by  the  sacri- 
fice of  the  other,  cannot  conceivably  have  any  other  than 
equal  importance  from  this  point  of  view,  and  it  is  mean- 
ingless to  speak  of  a  surplus.  The  situation  is  especially 
clear  in  an  exchange  system  wkith  fixed  prices  where 
things  can  be  converted  at  will  at  known  rates  by  purchase 
and  sale.  We  submit  that  it  is  clearly  impossible,  in  such  a 
situation,  to  conceive  of  things  serving  as  motives  to  ac- 
tion in  any  other  than  the  established  ratios  of  conversion 
or  substitution. 

For  understanding  the  psychology  of  valuation,  the  two 
points  are  equally  important:  (1)  that,  logically,  choice  is 
a  matter  of  comparing  alternatives  and  combining  them 
according  to  the  law  of  rational  procedure  above  formu- 
lated,1 and  (2)  that  there  is  none  the  less  a  practical  differ- 
ence between  two  kinds  of  alternatives  in  an  ordinary 
situation.  This  difference  is  perhaps  connected  with  the 
distinction  between  our  feelings  of  painfulness  and  pleas- 
antness, but  in  its  essence  it  relates  to  the  quantitative 
character  of  the  alternatives  (in  their  physical  aspects,  not 
the  psychic  states  involved).  In  the  case  just  considered,  of 
the  boy  and  berries,  the  difference  is  evident  from  the  fact 

seems  to  fail  utterly  to  substantiate  the  existence  of  the  phenomenon, 
A  man  might  pay,  say,  a  thousand  dollars  for  the  "first"  loaf  of  bread 
(whichever  one  that  is)  rather  than  do  without  it,  but  it  does  not  follow 
and  is  not  true  that  when  he  gets  it  for  a  dime  he  gets  $999.90  worth  of 
free  satisfaction.  Various  thinkers  have  perceived  the  mythical  character 
of  these  alleged  surpluses;  it  is  hoped  that  the  argument  above  will  sug- 
gest the  source  of  the  error  and  so  render  it  more  easily  identified  and 
avoided. 

1  Pages  64,  65. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       73 

that  we  use  the  berry  alternative  to  measure  the  leisure 
alternative.  We  speak  of  a  certain  quantity  of  berries  and 
the  sacrificed  alternatives  corresponding  to  them,  not 
of  a  certain  quantity  of  alternative  independently  deter- 
mined. The  "trouble,"  "exertion,"  or  what-not  is  not 
quantitative  on  its  own  account,  it  is  measured  by  the 
berries;  it  is  "the"  amount  of  exertion,  etc.,  connected  with 
a  specified  amount  of  the  measurable  commodity.  This 
result  is  inevitable  because,  as  remarked  above,  "the"  al- 
ternative is  not  in  fact  some  particular  alternative,  but  any 
alternative;  it  is  not  merely  not  measurable,  but  is  hetero- 
geneous and  wholly  indeterminate.  It  is  this  fact  which 
throws  us  back  on  the  conception  of  "resources"  for  ra- 
tionalizing the  deliberative  process,  making  of  it  a  quan- 
titative comparison;  it  is  this  fact  which  gives  its  great 
importance  to  the  "time"  measure  of  effort.  Time  does 
not  in  any  true  sense  measure  the  alternative  or  sacrifice, 
and,  as  we  have  seen,  its  employment  in  any  use  is  a  sacri- 
fice in  the  first  place  only  because  there  are  other  uses  for 
it,  which  are  the  real  sacrifice;  but  it  is  measurable,  and  our 
intelligence,  forced  to  have  something  quantitative  to  feed 
upon,  like  the  proverbial  drowning  man  catches  at  any 
straw. 

In  spite,  therefore,  of  the  purely  relative  character  of 
pain  and  pleasure  and  of  the  essential  parity  as  motives  of 
all  alternatives  of  conduct,  it  is  pragmatically  necessary 
to  distinguish  in  productive  activity  between  the  incoming 
"economic"  utility  and  the  sacrificed  (resources,  repre- 
senting) non-economic,  unspecified  alternatives  in  general, 
between  utility  and  disutility,  or  commodity  and  cost. 
"Cost,"  in  this  sense,  is  "pain  cost,"  or  "opportunity  cost," 
as  one  prefers;  there  is  no  real  difference  in  meaning  be- 
tween the  two. 

From  this  long  but  apparently  necessary  discussion  of 
the  fundamentals  of  valuation  of  psychology,  we  may  pro- 
ceed to  consider  a  somewhat  more  complicated  situation, 


74.  RISK,  UNCERTAINTY,  AND  PROFIT 

as  an  approach  to  the  study  of  the  principles  as  mani- 
fested in  the  field  of  exchange  relations.  We  will  suppose 
an  individual  choosing  between  the  production  and  con- 
sumption of  a  large  number  of  "  commodities,' '  in  addition 
to  the  alternative  of  not  producing  any  of  them,  but  of 
putting  his  time,  etc.,  to  "non-economic"  uses.  This  is  the 
situation  of  Crusoe  on  his  island,  of  which  many  economists 
have  made  use.  The  same  law  of  choice  will  hold  as  before; 
between  any  two  alternatives  or  among  all  that  are  open, 
the  man  will  choose  such  amounts,  or  divide  his  time  and 
"resources"  among  them  in  such  proportions,  that  the 
physically  alternative  or  correlated  quantities  of  all  are  to 
him  equally  desirable.  The  only  difference  is  that  the  alter- 
natives are  more  complicated  than  in  the  case  of  the  boy 
and  his  berries,  and  of  a  somewhat  different  character;  in 
particular,  the  presence  of  a  number  of  economic  alterna- 
tives, involving  concrete,  measurable  sources  of  satisfac- 
tion, is  important. 

In  Crusoe's  mind  there  would  undoubtedly  be  built  up 
something  of  the  nature  of  a  price  system  or  value  scale,  if 
he  seriously  attempted  to  get  the  maximum  of  satisfaction 
out  of  the  conditions  of  his  environment.  For  an  "intelli- 
gent" use  of  his  opportunities  can  be  arrived  at  in  no  other 
way.  He  must  ascertain  the  ratios  in  which  different  goods 
are  to  be  obtained  for  subjectively  equivalent  sacrifices  in 
"effort,"  and  similarly  form  judgments  of  their  relative 
subjective  importance  to  him,  and  attempt  to  bring  the 
two  sets  of  ratios  into  coincidence.  But  a  set  of  equivalence 
ratios  or  scale  of  equivalent  amounts  of  things  is  the  essence 
of  a  price  system.  Exchange  is  a  means  by  which  things 
may  be  conveniently  converted  into  or  sacrificed  for  each 
other  in  determinate  amounts,  and  substantially  the  same 
result  follows  from  choosing  between  different  lines  of 
production  in  a  Crusoe  economy.  It  is  sufficiently  evi- 
dent that  the  quantities  involved  in  such  a  calculation  are 
quantities  of  things  and  not  of  satisfaction  or  any  psychic 
magnitude. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE      75 

The  role  of  the  "resource"  idea  and  the  concept  of 
"cost"  will  also  take  on  characteristic  form  in  the  Crusoe 
case.  The  mental  labor  of  evaluating  everything  in  terms 
of  everything  else  must  force  recourse  to  a  crude  meas- 
urement of  "effort"  as  the  common  standard  of  value  or 
"medium  of  exchange"  (it  is  almost  like  that)  for  medi- 
ating the  comparisons.  It  is  clear  that  this  is  an  "in- 
strumental" but  none  the  less  very  important  device. 
"Really,"  it  is  purely  a  question  of  combining  alternatives, 
among  which  are  those  indefinite,  "non-economic"  occu- 
pations, exploring  the  island,  chatting  with  the  parrot, 
sport  or  recreation  of  any  appealing  kind,  or  "loafing  and 
inviting  the  soul."  But  the  indefinite,  heterogeneous,  and 
uncertain  character  of  these  last,  and  the  convenience 
of  "time"  as  a  rough  basis  for  an  approximate  evaluation 
of  the  stuff  they  are  made  of,  make  it  a  matter  of  economy 
to  resort  to  its  use  as  a  common  denominator  of  alterna- 
tives. It  will  not  be  true  that  all  things  produced  in  equal 
times  will  be  equated,  for  there  are  elements  of  "irksome- 
ness,"  etc.,  which  have  to  be  taken  account  of.  Crusoe's 
value  scale  will  probably  be  based  on  time  as  a  "first  ap- 
proximation" with  mental  allowances  for  the  other  factors 
to  be  considered. 

Measurement  relations  will  be  reciprocal,  in  this  case  as 
always.  The  use  of  effort  to  measure  other  things  amounts 
to  an  evaluation  of  effort  in  terms  of  other  things.  Thus 
we  get  the  concept  of  a  quantitative  outlay  cost  meaning 
something  more  than  merely  any  sacrificed  alternative. 
As  pointed  out  before,  in  stating  in  terms  of  "resources" 
the  general  law  of  choice  among  alternatives,  this  con- 
cept of  cost  has  no  very  substantial  independent  meaning; 
"when  pressed"  we  reformulate  our  resource  or  effort  (or 
money)  costs  in  terms  of  positive  alternatives  we  might 
have  had;  but  as  a  mediating,  instrumental  idea,  it  is  none 
the  less  a  useful  and  universally  used  notion.  There  is, 
however,  no  occasion  to  speak  of  a  possible  divergence 


76  RISK,  UNCERTAINTY,  AND  PROFIT 

between  outlay  cost  and  value  return,  of  anything  like  a 
"profit"  from  operations. 

There  are  many  intermediate  stages  in  the  successive 
complication  of  alternatives  which  might  be  discussed,  and 
which  would  shed  light  on  various  phases  of  economic 
relations;  but  for  present  purposes  it  is  best  to  pass  at 
once  to  the  case  of  a  group  of  people  producing  goods  for 
exchange  in  a  free  market.  The  relations  among  the  want- 
satisfying  activities  of  a  plurality  of  persons  are  based 
upon  another  "conflict,"  the  conflict  between  similar  wants 
of  different  individuals,  to  a  large  extent  dependent  on 
common,  immediate  means  of  satisfaction,  while  these  im- 
mediate goods  are  almost  entirely  dependent  upon  a  com- 
mon fund  of  ultimate  productive  resources.  The  effect  of 
the  possibility  of  exchange  is  vastly  to  multiply  and  com- 
plicate the  alternatives  open  to  any  individual.  He  is  now 
free,  not  merely  to  make  any  possible  combination  of  com- 
modities for  production  and  consumption,  but  to  com- 
bine the  production  of  some  with  the  consumption  of  any 
combination  —  on  terms  afforded  by  an  established  set  of 
exchange  ratios,  the  investigation  of  which  is  the  principal 
problem  before  us.  In  order  to  study  first  the  most  essen- 
tial features  of  exchange  relations,  it  will  be  necessary  to 
simplify  the  situation  as  far  as  possible  by  a  process  of 
"heroic"  abstraction.  We  therefore  explicitly  make  the 
following  assumptions  as  to  the  characteristics  of  our  im- 
aginary society: 

1.  The  members  of  the  society  are  supposed  to  be  nor- 
mal human  beings  in  essential  respects  as  to  inherited  and 
acquired  dispositions,  differing  among  themselves  in  the 
ways  and  to  the  degrees  familiar  in  a  modern  Western 
nation  —  a  "random  sample"  of  the  population  of  the 
industrial  nations  of  to-day. 

%.  We  assume  that  the  members  of  the  society  act  with 
complete  "rationality."  By  this  we  do  not  mean  that  they 
are  to  be  "as  angels,  knowing  good  from  evil";  we  assume 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       77 

ordinary  human  motives  (with  the  reservations  noted  in 
the  following  paragraphs);  but  they  are  supposed  to  "know 
what  they  want"  and  to  seek  it  "intelligently."  Their  be- 
havior, that  is,  is  all  "conduct,"  as  we  have  previously  de- 
fined the  term;  all  their  acts  take  place  in  response  to  real, 
conscious,  and  stable  and  consistent  motives,  dispositions, 
or  desires;  nothing  is  capricious  or  experimental,  every- 
thing deliberate.  They  are  supposed  to  know  absolutely 
the  consequences  of  their  acts  when  they  are  performed, 
and  to  perform  them  in  the  light  of  the  consequences. 

3.  The  people  are  formally  free  to  act  as  their  motives 
prompt  in  the  production,  exchange,  and  consumption  of 
goods.  They  "own  themselves";  there  is  no  exercise  of 
constraint  over  any  individual  by  another  individual  or  by 
"society";  each  controls  his  own  activities  with  a  view  to 
results  which  accrue  to  him  individually.  Every  person  is 
the  final  and  absolute  judge  of  his  own  welfare  and  in- 
terests.1 

4.  We  must  also  assume  complete  absence  of  physical 
obstacles  to  the  making,  execution,  and  changing  of  plans 
at  will;  that  is,  there  must  be  "perfect  mobility"  in  all 
economic  adjustments,  no  cost  involved  in  movements  or 
changes.  To  realize  this  ideal  all  the  elements  entering 
into  economic  calculations  —  effort,  commodities,  etc.  — 
must  be  continuously  variable,  divisible  without  limit. 
Productive  operations  must  not  form  habits,  preferences, 
or  aversions,  or  develop  or  reduce  the  capacity  to  perform 

1  Dependent  members  of  the  society  must  be  completely  dependent  on 
some  particular  individual  in  it.  The  wants  of  any  dependent  person  will 
then  operate  only  through  wants  on  his  behalf  felt  by  his  sponsor,  and  we 
need  not  consider  them  at  all.  We  need  simply  regard  the  independent 
members  of  the  society  as  having  normal  solicitudes  in  regard  to  families, 
etc.,  but  each  person  enters  into  economic  life  on  an  absolute  equality 
with  others  or  not  at  all. 

The  meaning  of  the  above  assumptions  is  not  necessarily  that  they 
form  a  complete  description  of  the  people  and  their  relations.  This  is 
but  an  emphatic  way  of  saying  that  we  here  consider  only  their  mar- 
ket behavior,  which  is  assumed  to  conform  to  these  specifications. 


78  RISK,  UNCERTAINTY,  AND  PROFIT 

them.  In  addition,  the  production  process  must  be  con- 
stantly and  continuously  complete;  there  is  no  time  cycle 
of  operations  to  be  broken  into  or  left  incomplete  by  sud- 
den readjustments.  Each  person  continuously  produces  a 
complete  commodity  which  is  consumed  as  fast  as  pro- 
duced. The  exchange  of  commodities  must  be  virtually 
instantaneous  and  costless. 

5.  It  follows  as  a  corollary  from  number  4  that  there 
is  perfect  competition.  There  must  be  perfect,  continuous, 
costless  intercommunication  between  all  individual  mem- 
bers of  the  society.1  Every  potential  buyer  of  a  good  con- 
stantly knows  and  chooses  among  the  offers  of  all  potential 
sellers,  and  conversely.  Every  commodity,  it  will  be  re- 
called, is  divisible  into  an  indefinite  number  of  units  which 
must  be  separately  owned  and  compete  effectually  with 
each  other. 

6.  Every  member  of  the  society  is  to  act  as  an  individual 
only,  in  entire  independence  of  all  other  persons.  To  com- 
plete his  independence  he  must  be  free  from  social  wants, 
prejudices,  preferences,  or  repulsions,  or  any  values  which 
are  not  completely  manifested  in  market  dealing.  Ex- 
change of  finished  goods  is  the  only  form  of  relation  be- 
tween individuals,  or  at  least  there  is  no  other  form  which 
influences  economic  conduct.  And  in  exchanges  between 
individuals,  no  interests  of  persons  not  parties  to  the  ex- 
change are  to  be  concerned,  either  for  good  or  for  ill.  In- 
dividual independence  in  action  excludes  all  forms  of 
collusion,  all  degrees  of  monopoly  or  tendency  to  monopoly. 

7.  We  formally  exclude  all  preying  of  individuals  upon 
each  other.  There  must  be  no  way  of  acquiring  goods 
except  through  production  and  free  exchange  in  the  open 
market.  This  specification  is  really  a  corollary  from  num- 
bers 2  and  3,  which  exclude  fraud  or  deceit  and  theft  or 

1  It  goes  without  saying  that  our  imaginary  society  is  "isolated." 
Every  individual  who  has  anything  at  all  to  do  with  it  is  in  it  and  of  it  on 
a  par  with  all  the  rest. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       79 

brigandage  respectively,  but  it  deserves  explicit  mention. 

8.  The  motives  for  division  of  labor  and  exchange  must 
be  present  and  operative.  These  have  never  been  ade- 
quately treated  in  the  literature  of  economics  in  spite  of 
the  fact  that  the  subject  has  been  discussed  more  or  less 
by  countless  writers  on  social  problems  from  Plato  down. 
The  principal  condition  is  diversification  of  wants  associated 
with  specialization  of  productive  capacities  or  dispositions, 
or  with  physical  restrictions  on  the  range  of  productive 
activity.  An  important  fact  in  this  connection  in  the  real 
world  is  the  space  distribution  of  the  different  resources  of 
the  earth  and  the  limitations  on  human  mobility.  In 
addition  the  physical  nature  of  the  production  process  fre- 
quently calls  for  the  simultaneous  prosecution  of  a  number 
of  operations.  For  simplicity  we  shall  assume  that  the  first 
two  conditions  alone  are  sufficient  to  restrict  each  individ- 
ual to  the  production  of  one  single  commodity  at  any  given 
time.   (Cf.  number  11.) 

9.  All  given  factors  and  conditions  are  for  the  purposes 
of  this  and  the  following  chapter  and  until  notice  to  the 
contrary  is  expressly  given,  to  remain  absolutely  un- 
changed. They  must  be  free  from  periodic  or  progressive 
modification  as  well  as  irregular  fluctuation.  The  con- 
nection between  this  specification  and  number  2  (perfect 
knowledge)  is  clear.  Under  static  conditions  every  person 
would  soon  find  out,  if  he  did  not  already  know,  every- 
thing in  his  situation  and  surroundings  which  affected  his 
conduct. 

The  above  assumptions,  especially  the  first  eight,  are 
idealizations  or  purifications  of  tendencies  which  hold  good 
more  or  less  in  reality.  They  are  the  conditions  necessary 
to  perfect  competition.  The  ninth,  as  we  shall  see,  is  on  a 
somewhat  different  footing.  Only  its  corollary  of  perfect 
knowledge  (specification  number  2)  which  may  be  present 
even  when  change  takes  place,  is  necessary  for  perfect 
competition.  In  addition  to  these  differences  in  degree  only 


80  RISK,  UNCERTAINTY,  AND  PROFIT 

from  actual  life,  we  must  lay  down  for  the  special  purpose 
of  the  immediate  analysis  two  further  suppositions  quite 
contrary  to  the  facts. 

10.  The  first  is  that  for  the  present  there  is  to  be  no 
productive  property  in  the  ordinary  sense  in  the  society. 
Every  productive  agency  or  capacity  is  an  inseparable 
part  of  the  personal  endowment  of  some  member  of  the 
society.  Material  implements  of  production  may  be  used 
provided  they  are  either  superabundant,  and  consequently 
free  goods,  or  else  are  absolutely  joined  to  their  owners 
(not  subject  to  lease  or  sale)  and  not  subject  to  increase  or 
decrease.  The  last  characteristic,  if  not  that  of  insepara- 
bility, is,  of  course,  really  implied  in  the  specification  of 
static  conditions. '  We  must  also  observe  explicitly  that 
personal  powers  themselves  are  similarly  fixed  in  amount 
and  character.  The  social  consequences  of  the  transfer  of 
productive  goods  between  individuals,  and  especially  of 
their  increase  by  "investment,"  will  call  for  extended  dis- 
cussion later,  and  must  be  isolated  by  a  preliminary  study 
of  a  society  in  which  they  are  absent. 

11.  The  second  "analytic"  assumption  is  also  contained 
in  the  preceding  "idealizing"  group.  Under  number  8  we 
declared  that  division  of  labor  was  to  be  carried  to  the 
point  where  each  individual  produced  a  single  commodity. 
In  modern  industrial  life  it  is,  of  course,  carried  vastly 
farther.  But  it  is  important  to  study  separately  a  society 
where  production  is  organized  through  the  exchange  of 
finished  products  only.1  At  a  later  stage  we  can  then  dis- 
cuss the  special  problems  of  that  further  stage  of  organiza- 
tion called  secondary  division  of  labor. 

This  isolation  is  of  especial  importance  in  view  of  the 
fact  that  the  distribution  of  products  is  very  much  com- 
plicated when  the  agencies  of  production  cooperate  in  the 

1  We  might  characterize  such  a  society  as  a  "handicraft"  system  in 
contrast  with  "enterprise,"  in  which  the  operative  has  lost  his  responsible 
status  and  lives,  not  by  the  production  and  sale  of  a  commodity,  but  by 
the  sale  of  productive  services  to  an  entrepreneur. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       81 

production  of  a  single  commodity,  the  product  of  a  single 
agent  being  then  no  longer  immediately  identifiable.  The 
problem  of  isolating  the  product  of  a  single  agency,  where  a 
number  work  jointly,  is,  of  course,  the  familiar  problem  of 
"imputation"  or  distribution  in  the  technical  sense,  which 
has  been  the  greatest  single  center  of  controversy  in  eco- 
nomic discussion. 

The  above  list  of  assumptions  and  artificial  abstractions 
is  indeed  rather  a  formidable  array.  The  intention  has  been 
to  make  the  list  no  longer  than  really  necessary  or  useful, 
but  in  no  way  to  minimize  its  degree  of  artificiality,  the 
amount  of  divergence  of  the  hypothetical  conditions  from 
those  of  actual  economic  life  about  us.  For  the  most  part 
these  same  assumptions,  especially  the  first  eight,  and  to 
a  considerable  extent  the  ninth,  are  really  involved  at 
one  point  or  another  in  a  large  part  of  the  discussion  of 
economic  literature.  If  they  are  present,  and  necessary, 
and  when  present  whether  necessary  or  not,  there  will 
be  no  disparaging  the  importance  of  having  their  ab- 
stract and  unreal  character  brought  conspicuously  to  the 
surface. 

Our  next  task  is  to  form  a  picture  of  such  a  society  in 
action,  and  to  discover  the  conditions  of  equilibrium  or 
natural  results  of  the  operation  of  the  forces  and  tendencies 
at  work  in  it.  We  are  therefore  to  imagine  such  a  population, 
set  down  in  such  an  environment  as  described,  starting 
out  de  novo  in  the  business  of  satisfying  their  wants.  Each 
person,  on  taking  in  the  situation  in  its  essential  outlines, 
will  enter  upon  the  production  of  some  commodity,  with  a 
view,  through  exchange  with  others,  of  securing  the  means 
of  satisfying  his  varied  wants.  After  a  brief  interval  of 
time  has  elapsed,  each  will  have  accumulated  a  small  stock 
of  his  particular  good,  and  we  may  think  of  them  all  as 
meeting  in  a  central  market  to  exchange  their  wares. 

The  situation  now  presented  is  the  familiar  one  in 
economic  discussion,  of  a  group  of  individuals  with  given 


82  RISK,  UNCERTAINTY,  AND  PROFIT 

stocks  of  goods  which  have  to  be  disposed  of,1  and  we  need 
not  dwell  upon  the  process  by  which  fixed  rates  of  exchange 
among  all  commodities  will  be  established.2  When  the 
process  is  finished  the  whole  mass  of  commodities  will  have 
been  reduced  to  a  single  homogeneous  fund  of  exchange 
equivalence  or  value.  Nor  do  we  need  to  concern  ourselves 
with  the  mode  of  expressing  and  handling  this  fund;  in 
practice  it  would  be  inevitable  that  some  sort  of  standard 
exchange  medium  would  be  set  apart;  but  it  is  immaterial 
for  present  purposes  whether  there  is  some  one  kind  of 
money  or  as  many  kinds  as  there  are  different  com- 
modities. 

If  intercommunication  is  actually  perfect,  exchanges 
can  take  place  at  only  one  price.3  We  may  imagine  it  to  be 
determined  all  around  what  the  ratios  are  to  be  through 
the  medium  of  inquiries.  Every  individual,  knowing  the 
worth  of  the  thing  he  possesses  in  terms  of  everything  else, 
is  in  substantially  the  same  position  as  a  person  spending  a 
given  money  income  in  a  market  where  selling  prices  are 
fixed  by  the  seller  and  placarded.  The  good  in  his  hands 
represents  exchange  power,  a  "resource,"  and  he  will  ap- 
portion it  among  the  possible  uses  according  to  the  law  of 
choice,  so  that  each  unit  of  it  purchases  equivalent  utili- 
ties, want  satisfactions,  or  "importances." 

1  We  treat  the  entire  stock  as  for  sale  without  reserve.  The  demands 
of  present  owners  for  their  own  goods,  which  underlie  any  possible  reser- 
vation prices,  are  in  fact  no  different  from  the  demand  of  other  persons, 
and  the  situation  as  a  whole  is  most  truthfully  and  significantly  represented 
as  given  quantities  of  goods  over  against  given  dispositions  to  own  them, 
since  the  question  of  whose  disposition  it  is  has  nothing  to  do  with  the 
price  that  will  be  established.  We  must,  of  course,  include  the  demand  of 
present  owners  in  the  demand  for  every  good;  that  it  is  "backed  up"  by 
the  good  itself  instead  of  some  other  good  in  hand  has  nothing  to  do  with 
the  result.   (Cf .  Davenport,  Economics  of  Enterprise,  chap,  v,  pp.  48  ff .) 

2  The  problem  of  a  perfect  market  is  best  treated  mathematically 
(i.e.,  symbolically)  and  has  been  well  handled  by  mathematical  econ- 
omists. See  Edgeworth,  Mathematical  Psychics,  pp.  40  ff.,  and  Marshall, 
Principles,  Appendix  F,  and  Mathematical  Appendix,  note  xn  bis. 

3  Easily  proved  by  disproving  the  contrary.  If  exchanges  be  thought 
of  as  taking  place  at  different  prices  the  buyer  at  the  higher  price  and 
seller  at  the  lower  will  get  together  at  an  intermediate  figure. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       83 

To  show  just  how  the  price  scale  itself  results  from  the  " 
fact  that  individuals  act  according  to  the  law  of  choice  in 
apportioning  their  purchasing  power  in  a  situation  where 
the  prices  are  given,  is  the  task  of  that  branch  of  eco- 
nomics known  as  the  theory  of  market  price.  At  any 
given  price  (ratio  of  sacrificing  one  good  for  the  other)  the 
more  purchasing  good  is  expended  for  any  one  commodity 
the  less  becomes  the  amount  of  want  satisfaction  pur- 
chased with  each  unit  (relatively  to  the  want-satisfying 
capacity  either  of  the  good  given  up  or  of  any  other  good 
for  which  it  might  have  been  exchanged).  From  this  it 
follows  that  the  higher  the  price  of  any  good  (relative  to 
others,  including  the  purchase  good),  the  less  of  it  will  be 
purchased  by  any  individual.1  It  is  therefore  theoretically 
possible  to  construct  a  schedule,  or  curve,  of  the  amounts 
of  any  good  that  will  be  taken  by  any  individual  at  every 
price  in  terms  of  other  goods,  and  by  adding  these  amounts  ? 
fprjdl  individuals,  to  construct  a  similar  schedule  for  the 
society  as  a  whole.  But  there  is  a  fixed  amount  of  each 
good  available  in  any  given  short  space  of  time  to  be  dis- 
posed of,  and  it  must  all  be  sold  at  one  price.  Therefore, 

1  These  two  propositions  are  often  treated  as  equivalent  in  economic 
discussion,  but  the  relation  between  them  is  not  so  simple  as  that.  To 
prove  the  second  from  the  first,  suppose  that  at  any  given  price  the  in- 
dividual has  determined  upon  the  proper  amount  to  purchase.  (For  the 
sake  of  similarity  with  the  pecuniary  situation  let  us  leave  the  purchase 
good  out  of  account  and  think  of  a  comparison  between  two  commodities 
being  bought  with  money  which  has  no  commodity  value.)  Now  let  the 
price  of  one  commodity  rise,  relatively  to  that  of  another.  If  the  com- 
modity which  has  risen  in  value  is  a  very  important  one,  it  is  probable 
that  the  individual  will  spend  as  much  of  his  resources  for  it  as  before, 
quite  possibly  even  more.  But  he  will  not  buy  as  much  of  the  commod-. 
ity,  measured  in  physical  units.  For  to  do  so  he  would  have  to  spend  cor- 
respondingly less  resources  for  the  alternative  good,  and  buy  less  of  it. 
But  if  he  buys  the  same  amount  of  one  good  as  before,  and  less  of  the 
other,  the  utility  ratio  between  the  two  is  upset  (since  it  was  in  equilib- 
rium), and  a  given  amount  of  resources  is  buying  less  utility  in  the  good 
of  which  relatively  more  is  purchased;  resources  will  therefore  be  di- 
verted from  this  good  to  the  other.  That  is,  he  will  buy  less  of  the  good 
which  has  risen  (relatively)  in  price.   Q.  E.  D. 


84  RISK,  UNCERTAINTY,  AND  PROFIT 

in  a  perfect  market  each  commodity  will  command  a  def- 
inite price,  which  is  the  highest  uniform  price  at  which  the 
entire  existing  stock  can  be  disposed  of  (including  taking 
out  of  the  market  by  present  owners). 

The  diagrammatic  representation  of  the  market-price 
equilibrium  is  simple  and  obvious.  The  utility  relations 
involved  in  the  figures  and  analysis  for  the  boy-and-berries 
situation  above  x  are  applicable.  The  exchange  situation 
is  shown  in  the  accompanying  sketch.  The  horizontal  base 
line  is  a  scale  of  prices.  The  "demand"  curve  D  shows  the 

potential  purchases  at  each 
price,  for  any  individual  or 
for  the  society  as  a  whole, 
according  to  the  scale  used. 
The  amount  for  sale  is  in- 
dependent of  price,  a  fixed 
physical  quantity,  and  is 
represented  by  a  horizontal 
line  cutting  the  vertical  or 
commodity  axis  at  the  proper  point.  The  horizontal  value 
of  the  intersection  point  gives  the  market  price  under  the 
conditions.2 

It  is  especially  to  be  observed  that  all  the  quantities  in- 
volved in  this  whole  analysis  are  physical  and  not  psychic. 
If  utility  in  the  individual  consciousness  is  not  a  true, 
measurable  magnitude,  as  argued,  it  is  still  more  evident 
that  utility  in  any  social  sense,  involving  a  sublimation  of 
individual  utilities  into  a  "social"  estimate  is  a  wholly  in- 
admissible supposition.  The  concept  of  social  utility  is  in 

1  Pages  66  ff. 

2  It  is  also  possible,  but  complicates  matters  needlessly,  to  plot  the 
demand  of  others  than  present  owners  of  the  good,  only,  in  the  demand 
curve,  and  draw  an  ascending  curve  to  represent  the  sales  at  different 
prices,  taking  account  of  the  present  holders'  reservation  prices.  The 
same  data  will  give  the  same  price  point  whichever  method  is  used,  and 
the  one  described  in  the  text  is  the  more  significant  description  of  the 
situation,  since  there  is  no  practical  difference  in  the  causes  or  motives 
back  of  reservation  prices  and  demand  prices. 


Prices 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       85 

fact  a  mere  substitute  for  analysis.  The  whole  problem  is 
precisely  this  of  showing  how  an  objective  and  uniform 
price  results  from  palpably  subjective  and  variable  in- 
dividual preferences.  This  must  be  done  by  exhibiting  the 
interactions  of  individual  offers  and  bids  in  the  actual 
market.1  We  in  fact  know  nothing  about  any  absolute 
utility  to  any  individual  or  about  absolute  amounts  pur- 
chased by  any  one.  All  that  can  be  said  about  the  ad- 
justment which  results  from  perfect  competition  is  com- 
prised in  three  statements:  (1)  Under  the  conditions  (the 
price  alternatives  as  they  are  fixed)  each  individual  achieves 
the  goal  of  rational  action,  maximizing  the  want  satisfac- 
tion procurable  with  his  given  resources  (whatever  they 
are)  in  purchasing  power,  by  distributing  them  among  the 
alternatives  according  to  the  law  of  choice;  (2)  the  condi- 
tions themselves,  the  prices  or  exchange  ratios  being  the 
same  for  all  individuals,  and  the  relative  utilities  adjusted 
to  equality  with  these,  it  follows  that  the  relative  utilities 
of  all  goods  (which  any  individual  purchases  at  all)  are  the 
same  to  every  individual;  (3)  the  exchange  ratios  will  be 
so  adjusted  that  at  those  ratios  no  individual  will  wish  to 
exchange  anything  in  his  possession  for  anything  in  the 
possession  of  any  one  else. 

The  emphasized  expressions  are  so  treated  because  of 
current  ambiguous  or  actually  confused  conclusions  in  re- 
gard to  the  beneficence  of  the  results  of  ideal  competition. 
To  call  this  result  socially  ideal  or  the  best  possible,  in- 
volves assuming  in  addition  to  all  the  theoretical  condi- 

1  Seligman's  treatment  (Principles  of  Economics,  pp.  179  ff.  and  192  ff.) 
is  a  particularly  glaring  instance  of  the  organism  fallacy.  B.  M.  Ander- 
son, Jr.'s  Social  Value  involves  the  same  error.  Anderson  palpably  con- 
fuses social  influences  back  of  individual  judgments  and  preferences  with 
social  judgments  and  preferences  in  any  proper  sense.  Of  course  the 
individual  is  a  social  product,  but  consciousness  is  still  an  individual 
phenomenon,  and  the  conduct  with  which  economists  are  concerned  no 
less  so.  It  is  individual  purchases  and  sales  which  fix  prices,  not  social, 
unless  in  a  socialistic  state  or  one  organized  in  some  other  way  than 
through  free  exchange  between  individuals,  the  kind  economics  deals 
with. 


86  RISK,  UNCERTAINTY,  AND  PROFIT 

tions  as  to  the  workings  of  the  process  itself1  that  the 
initial  situation,  the  distribution  of  goods  before  the  ex- 
changes commenced,  was  the  best  possible  (i.e.,  either  ab- 
solutely ideal  or  absolutely  beyond  human  power  to  mod- 
ify). All  that  is  true  (and  stated  baldly  it  is  little  better 
than  a  truism)  is  that  free  exchange  tends  toward  that 
redistribution  of  goods  which  is  the  most  satisfactory  all 
around  of  any  that  can  be  obtained  by  voluntary  consent 
all  around. 

It  is  self-evident  that  in  ideal  exchange  the  quantities  ex- 
changed are  equal  in  value  terms,  and  there  is  no  chance 
for  anything  like  a  "profit"  to  arise. 

The  main  condition  of  perfect  exchange  not  realized  in 
real  life  is  that  of  "perfect  intercommunication,"  which  is 
to  say  perfect  knowledge  of  what  they  are  doing  on  the 
part  of  all  exchangers.2 

In  our  actual  system  middlemen  fix  a  price  which  inihe 
absence  of  monopoly  is  their  best  estimate  of  the  theoreti- 
cal price  —  which  would  just  enable  the  visible  supply  to 
be  disposed  of  —  and  change  it  from  time  to  time  as  the 
rate  of  sales  indicates  it  to  be  too  high  or  too  low.  It  is  a  fa- 
miliar fact  that  in  consequence  of  imperfect  intercommuni- 
cation appreciably  different  prices  for  the  same  commodity 
may  obtain  at  different  points  in  the  general  market  area. 
Certain  factors  aggravate  the  effect  of  uncertainty  in  dis- 

1  See  above,  pp.  76-80. 

2  The  use  of  money  does  not  affect  the  theory  at  all,  and  the  use  of 
circulating  credit  not  in  any  way  that  vitiates  the  argument,  if  it  does  not 
change  in  value. 

In  one  respect  the  actual  situation  is  very  much  simplified  as  com- 
pared with  the  theoretical,  and  the  disparities  which  would  otherwise 
arise  mitigated.  The  continuity  of  the  process  and  the  constant  existence 
of  published  prices  means  in  general  that  sellers  will  not  come  into  the 
market  at  all  unless  they  are  willing  to  take  the  quoted  price  (or  more) 
and  buyers  not  unless  they  are  willing  to  pay  that  or  anything  less.  It  is 
then  easy  to  see  how  an  excess  of  goods  offered  or  an  excess  of  purchase 
offers  will  move  the  price  downward  or  upward  to  the  equilibrium  point. 
The  real,  practical  problem,  that  is,  relates  to  price  changes,  not  to  the 
establishment  of  price,  and  is  vastly  less  complicated  than  the  latter. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       87 

turbing  the  theoretical  adjustment:  (1)  Inertia  or  inflexi- 
bility of  prices,  due  to  habit,  indifference,  rounding  off  of 
figures,  etc.;    (2)   variations  in  the  "con..  "   (and 

fraudulent  representations   of  variations  h    *io  not 

exist);  and  this  both  in  the  crude  physical  a  i  still 

more  in  by-perquisite  utilities,  convenience  or  fa  ihionable- 
ness  of  place  of  sale,  ornamental  containers,  v  mes, 

personality  of  vendor,  etc.;  (3)  consumers'  speculation; 
consumers  do  not  buy  continuously  for  their  current  needs, 
but  lay  in  supplies  or  hold  off,  according  to  their  prognos- 
tications of  the  market. 

When  terms  are  properly  defined  and  allowances  made 
for  real  commodity  differences  (which  include  all  the 
factors  under  number  2  above)  the  tendency  toward  a 
definite  and  uniform  price  for  similar  goods  is  strong  and 
conspicuous,  and  a  fair  approximation  to  this  result  is 
generally  reached.  There  is,  of  course,  the  greatest  differ- 
ence in  commodities  in  respect  of  this  standardization, 
from  wheat  and  cotton  at  one  extreme  to  artistic  products 
at  the  other.  ' 

When  in  our  imaginary  perfectly  competitive  society  the 
exchanges  are  finished  and  the  goods  consumed,  everybody 
will  again  start  out  to  engage  in  production.  But  occu- 
pations will  not  be  chosen  as  before;  there  will  now  be  an 
established  scale  of  prices  of  every  good  in  terms  of  every 
other,  and  in  accordance  with  this  price  scale  every  one  will 
direct  his  effort  and  gauge  its  intensity,  conforming,  of 
course,  to  the  Law  of  Choice  in  making  his  decision^  The 
commodities  produced  will  be  thought  of  simply  as  pur- 
chasing power  over  goods  in  general,  and  the  immediate 
alternatives  are  simply  producing  "wealth"  and  not  pro- 
ducing it,  which  means  doing  something,  or  nothing  (which 
is  also  doing  "something")  entirely  outside  the  scale  of 
quantitative  comparisons,  and  this  now  means  outside  the 
market  sphere.  Every  man  will,  therefore,  like  Crusoe,  or 
the  boy  in  the  berry  patch,  carry  his  exertions  to  the  point 


88  RISK,  UNCERTAINTY,  AND  PROFIT 

where  utility  and  disutility  —  "really"  sacrificed  utility, 
but  of  an  unspecified  and  non-quantitative  sort  —  are  of 
equal  importance  in  the  amounts  which  are  alternative  to 
each  other. 

As  production  goes  on  and  goods  accumulate  in  the 
hands  of  our  "homines  ceconomici,"  they  will  be  exchanged 
as  before,  distributed  among  the  exchange  possibilities  in 
accordance  with  the  Law  of  Choice;  and  the  exchange 
possibilities  will  continuously  be  modified  by  the  same 
process  so  as  to  be  kept  constantly  at  that  point  where 
momentarily  the  utility  ratios  of  every  one  can  be  brought 
to  equality  with  the  price  ratios.  But  this  process  of  ad- 
justment and  readjustment  also  tends  toward  an  equilib- 
rium; the  investigation  of  this  tendency  toward  a  condition 
in  which  production  and  consumption  of  all  commodities 
would  go  forward  at  unvarying  rates  falls  in  the  province 
of  the  second  grand  division  of  economic  theory,  one 
branch  of  which  is  the  theory  of  normal  price.1 
*  In  a  situation  such  as  we  have  described,  with  the  pro- 
duction, exchange,  and  consumption  of  commodities  going 
on  continuously,  the  value  scale  or  system  of  quantitative 
equivalences  of  commodities,  becomes  much  more  ob- 
jective and  definite  than  it  could  ever  be  in  the  economy 
of  an  individual  Crusoe.  The  constant  presence  of  the 
published  scale  of  exchange  ratios  and  the  working-out  of 
the  whole  organization  in  terms  of  it  must  have  a  tremen- 
dous influence  in  "rationalizing"  the  economic  activity,  in 
impressing  its  quantitative  features  on  men's  minds,  and 
enforcing  precise  calculations  and  comparisons.  The  re- 
sult is  that  all  goods  are  reduced  to  a  homogeneous  aggre- 
gate or  fund  of  value  units.  This  fund  of  value,  as  the 
medium  of  solving  the  problems  of  alternatives,  naturally 
divides  the  economic  process  for  each  individual  into  two 

1  The  other  branch  is  the  theory  of  distribution  under  static  condi- 
tions, but  under  our  present  assumptions  there  is  no  such  problem  since 
joint  production  is  absent. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       91 

On  the  production  side  of  the  twofold  alternative,  the 
utility  or  importance  of  any  good  is  its  purchasing  power, 
and  the  higher  the  price  the  more  of  it  will  be  produced,  for 
the  same  reason  that  Crusoe  would  produce  more  of  a 
more  wanted  good  or  an  individual  in  a  market  purchase 
more  of  a  similar  one.    But  the  higher  the  price  of  any 
good  the  less  of  it  can  be  disposed  of.    Now  since  the 
amounts  produced  and  disposed  of  are  axiomatically  the 
same,  the  price  will  move    ^ 
toward  the  point  at  which    S 
the  natural  amounts  of  pro-     g  g 
duction  and  sales  at  that     »e 
price  are  the  same.    Dia-     g'g 
"grammatically,  takin  g  again     §  ^ 
a  scale  of  prices  as  a  hori-    «£& 
zontal  basis,  an  ascending     $1: 

curve    will    represent    the    ^     ' —         ~~p~- 

(rate  of)  production  or  sup- 
ply at  different  prices  (in  terms  of  other  goods),  while  a 
descending  curve  will  represent  the  (rate  of)  sales  or  de- 
mand. The  intersection  of  the  curves  gives  the  price  point. 

A  slightly  different  way  of  viewing  exactly  the  same 
facts  will  make  clearer  the  individual  motivation  and  show 
the  bearings  of  the  idea  of  value-cost.  The  demand  curve, 
viewed  from  the  other  direction,  or  with  the  axes  inter- 
changed, is  in  fact  a  cost  of  production  curve.  cThe  amount 
produced  (in  unit  time,  the  rate  of  production)  at  any 
price  is  the  amount  that  can  be  produced  at  that  price 
without  either  profit  or  loss.  For  if  any  given  price  yields  ^ 
a  profit,  resources  will  be  diverted  to,  and  if  a  loss,  from 
the  production  of  that  good;  the  real  meaning  of  profit  is 
simply  that  resources  being  used  to  produce  other  goods 
(and  valued  in  the  other  uses)  will  yield  more  in  the 
production  of  the  good  in  question;  while  similarly,  loss 
means  that  resources  producing  the  good  in  question  are 
worth  more  in  other  uses  (their  value  being  determined 


92  RISK,  UNCERTAINTY,  AND  PROFIT 

by  that  of  the  best  use)  f  From  the  present  point  of  view 
the  demand  curve  shows  the  possible  selling  prices  of 
different  sizes  of  supply,  and  the  condition  of  equilibrium 
t/  is  that  cost  and  selling  price  shall  be  equal.  The  inter- 
section of  the  curves  then  shows  on  one  axis  the  equili- 
brium rate  of  production  and  consumption,  and  on  the 
other  the  equilibrium  price.  The  character  of  the  whole 
analysis  as  an  easy  deduction  from  thestaw  of  Choic^  is 
clear  enough  without  further  elaboration.1^  ^^u^l^vi 
Space  does  not  permit  us  to  give  more  consideration  to 
these  first  fundamentals,  and  we  must  allow  the  above 
brief  and  perhaps  somewhat  dogmatic  treatment  of  con- 
troverted issues  to  stand.  It  is  difficult  in  the  light  of  such 
an  analysis  to  see  any  real  meaning  in  such  questions  as 
the  causal  relation  between  cost  and  value,  and  others  about 
which  controversy  has  raged.  cUnder  competitive  con- 
ditions a  value  involves  an  equal  cost  and  a  cost  an  equal 
•  value,  so  directly  and  obviously  (since  it  is  all  a  purely 
relative  matter  of  choosing  between  alternatives  in  such  a 
way  as  to  equate  them)  that  the  two  are  but  little  more 
than  different  words  for  the  same  phenomenon  viewed 
from  different  standpoints.  "3  Cost  is  the  value  of  the  re- 
sources embodied  in  a  thing,  which  is  to  say  the  value  of 
some  use  for  them;  it  may  be  an  "economic"  or  a  "non- 
economic"  (measurable  and  marketable  or  the  opposite) 
use,  but  if  there  is  not  a  competing  attraction  of  some 
sort  the  "resources"  will  not  be  "resources"  at  all,  just  as 
if  the  thing  itself  is  not  wanted  somewhere  else  it  will  not 

1  It  will  be  noticed  that  our  cost  curve  is  one  of  increasing  costs. 
This  is  the  only  case  to  be  considered  from  the  present  point  of  view.  The 
question  of  decreasing  costs  comes  in  at  a  later  stage  of  the  analysis  under 
more  complicated  conditions.  It  is  obvious  that  to  increase  the  pro- 
duction of  any  good  involves  the  diversion  of  resources  from  producing 
other  goods,  which  will  raise  their  value  while  lowering  that  of  the  good 
first  considered,  and  since  resources  are  valued  according  to  the  best 
available  use,  this  means  increasing  cost  with  increased  output.  At  the 
present  stage  of  the  argument  there  is  no  problem  as  to  the  cost  of  any 
unit  of  commodity  or  yield  of  any  unit  of  productive  agency,  since  only 
one  kind  of  agency  is  used  in  making  any  one  good. 


THEORY  OF  CHOICE  AND  OF  EXCHANGE       93 

have  (exchange)  value,  and  we  should  say  not  even  utility 
if  the  word  is  properly  defined. 

The  whole  argument  is  merely  an  elaboration  of  the  Law 
of  Choice  (the  correct  form  of  the  principle  of  utility),  that 
preference  ratios  between  alternatives  will  by  combining 
the  alternatives  in  the  requisite  proportions  be  made  equal 
to  the  externally  given  physical  equivalence  ratios,  first  in 
the  market  and  then  in  production.  That  "goods"  are 
largely  alternative  to  each  other  in  production  (involving 
the  use  of  the  same  ultimate  resources)  is  the  condition  of 
our  having  an  economic  order,  an  organization  of  want- 
satisfying  activities  based  on  free  production  and  exchange. 
We  turn  now  to  consider  the  further  complications  of  the 
competitive  situation  arising  from  the  organization  of  a 
plurality  of  productive  agents  in  the  making  of  a  single 
commodity. 


CHAPTER  IV 

JOINT  PRODUCTION  AND  CAPITALIZATION 

The  present  chapter  will  bring  a  greater  semblance  of 
reality  into  the  imaginary,  highly  simplified  economic 
system  partially  constructed  above.  Many  of  the  features 
of  everyday  life  abstracted  for  simplification  can  now  be 
introduced  in  succession  and  their  relations  and  bearings 
separately  studied.  In  this  way  we  shall  ultimately  deter- 
mine what  is  necessary  to  perfect  competition  and  what  is 
not.  It  will  be  found  that  most  of  the  simplifying  assump- 
tions hitherto  made  can  be  dropped  without  destroying  the 
conditions  necessary  to  a  perfect  equilibrium  in  which  costs 
and  values  are  identical  throughout.  So  long  as  we  adhere  to 
the  fundamental  condition  already  emphasized,  that  men 
know  exactly  what  they  are  doing,  that  no  uncertainty  is  pres- 
ent, other  elements  of  reality  hitherto  abstracted  merely 
complicate  the  process  of  adjustment  without  changing  the 
character  of  the  result.  Their  elimination  has  served  the 
necessary  end  of  simplifying  the  study  of  the  fundamen- 
tals of  economic  behavior  and  made  possible  the  separate 
study  of  these  complicating  considerations  themselves, 
which  we  shall  now  undertake. 

The  first  step  in  this  further  development  of  the  imagi- 
nary social  structure  is  to  examine  the  nature  and  bear- 
ings of  organized  production.  Hitherto  our  society  has 
been  arbitrarily  restricted  to  the  unorganized  or  individual 
creation  of  goods;  there  has  been  only  "primary"  division 
of  labor,  through  the  exchange  of  products.  We  now  turn 
to  consider  "secondary"  division  of  labor,  or  division  of 
occupations  within  the  separate  industries,  the  coopera- 
tion of  a  large  number  of  persons  in  the  making  of  a  single 
product.    This  added  element  in  the  situation  gives  us 


JOINT  PRODUCTION  AND  CAPITALIZATION     95 

two  serious  new  problems,  though  closely  related;  first,  the 
mechanism  of  the  actual  organization  of  productive  groups 
through  free  contract  alone,  and,  second,  the  division  of  a 
joint  product  among  the  individuals  making  different 
kinds  of  contributions  to  its  production.  The  latter  is  the 
familiar  problem  of  "imputation"  (Zurechnung)  or  "dis- 
tribution" in  the  technical  sense. 

Practically  speaking,  we  are  now  turning  to  the  second 
general  problem  of  economics  as  it  is  met  with  in  the  real 
world.  For  methodological  reasons  we  have,  indeed,  found 
it  necessary  to  discuss  a  society  in  which  specialized  pro- 
duction takes  place,  but  not  joint  production.  In  reality, 
of  course,  production  is  joint,  practically  without  excep- 
tion. The  subject  for  discussion  now  is,  therefore,  the 
general  principles  of  social  organization  under  free  ex- 
change where  given  resources  are  used  (in  the  production 
of  goods)  for  the  satisfaction  of  given  wants  (and  under 
given  conditions  as  to  available  methods  of  technical  or- 
ganization, etc.).  It  is  the  problem  of  the  "static  state." 
In  order  to  keep  the  problems  of  the  organization  of  pro- 
duction and  the  division  of  the  product  as  simple  as  possi- 
ble and  to  introduce  complicating  factors  one  at  a  time, 
no  other  changes  are  now  to  be  made  in  the  arbitrary  speci- 
fications of  the  system  we  are  studying.  In  regard  to  pro- 
duction particularly,  we  assume  the  absolutely  continuous 
creation  of  the  complete  article  and  its  immediate  exchange 
and  consumption  when  complete,  and  the  absence  of  pro- 
ductive "property"  in  the  ordinary  sense.1  That  is,  there 
are  to  be  no  material  productive  agents  which  are  not  either 
superabundant,  and  therefore  free,  or  else  rigidly  attached 
to  the  persons  of  their  owners,  and  no  way  is  to  be  open 
either  to  increase  the  productive  efficiency  of  person  or 
thing  or  to  decrease  it  through  use.  The  only  change  now 
introduced  in  the  conditions  of  our  problem  is  that  at  least 

1  See  above,  chapter  in,  pp.  76-80,  for  the  assumptions  under  which 
we  are  working. 


96  RISK,  UNCERTAINTY,  AND  PROFIT 

a  large  part  of  the  commodities  produced  and  consumed  in 
our  society  are  to  be  made  by  groups  of  individuals,  per- 
forming a  number  of  different  kinds  of  productive  work. 
It  is  not  necessary  that  every  individual  perform  a  unique 
function;  rather  let  it  be  typically  true  that  considerable 
numbers  perform  the  same  sort  of  work  and  that  there  are 
gradations  of  similarity  in  the  different  tasks.1 
c-The  possibility  of  an  automatic  organization  of  pro- 
duction through  free  agreements  between  individuals  de- 
pends upon  a  technological  principle  governing  joint  pro- 
duction and  not  hitherto  introduced.  This  new  axiom  is  as 
fundamental  to  economic  thought  and  process  as  the  prin- 
ciple of  choice  or  diminishing  utility,  and  very  similar  to  it 
in  statement.  It  is  the  principle  of  the  variation  of  pro- 
portions in  the  factors  of  production,  already  long  famous 
.Sunder  the  name  of  "diminishing  returns,"  though  its  clear 
and  approximately  accurate  formulation  in  general  terms  is 
a  relatively  recent  achievement.  This  new  law  is  a  general- 
ization from  the  facts  of  physical  nature  as  the  former  is  a 
generalization  from  the  facts  of  human  nature.^  Like  the 
other,  and  all  other  "laws,"  it  is  an  approximation,  and  its 
approximateness  must  be  kept  in  mind  in  making  practical 
applications  of  conclusions  resting  on  it  as  a  premise.  Like 
the  other  great  axioms  in  economics,  it  is  purely  a  princi- 
ple of  relativity,  dealing  with  proportions  only.'  In  this  re- 
spect the  current  statements  of  the  principle  are  generally 
les.  misleading  than  in  the  case  of  diminishing  utility, 
there  being  less  temptation  to  give  it  an  absolutistic  in- 
terpretation. It  does  seem  strange,  however,  that  it  took 
economists  so  long  (nearly  a  century)  to  recognize  the 
inherent  reversibility  of  a  change  in  proportions  and  to 
draw  the  obvious  inferences  from  the  fact.  We  may  ob- 
serve finally  that  the  new  principle  is  much"truer";  i.e., 
more  universally  and  accurately  in  conformity  with  the 

1  See  note  above,  p.  86  n.,  on  indifference  as  to  the  presence  and  use 
of  money. 


JOINT  PRODUCTION  AND  CAPITALIZATION     97 

facts,  more  dependable,  than  its  psychological  counter- 
part. 

In  many  other  respects,  also,  there  is  similarity  between 
the  two  fundamental  principles  of  proportionality,  the 
psychological  law  of  diminishing  utility  and  the  techno- 
logical one  of  diminishing  returns.  A  formal  and  accurate 
statement  of  either  presupposes  continuous  divisibility 
of  the  variable  element,  which  is  not  true  to  fact  in  a  par- 
ticular case,  but  which  does  hold  good  with  practical  ac- 
curacy in  a  large  market.  In  both  cases  divisibility  breaks 
down  completely  (in  an  individual  case)  for  minimum 
amounts.  As  there  is  a  definite  minimum  quantity  of  any 
consumption  good  required  to  give  it  any  significance,  so 
there  are  limits  to  the  proportions  of  productivity  agencies 
which  will  yield  any  effect  at  all.  As  to  minima  in  the  case 
of  consumption  goods  in  the  different  sense  of  minimum 
amounts  necessary  to  life,  this,  though  commonly  assumed, 
is  ordinarily  not  true.  It  is  only  under  very  special  circum- 
stances that  any  particular  commodity,  as  the  market  de- 
fines and  differentiates  commodities  (and  this  is  the  only 
sound  or  relevant  method),  is  indispensable.  ^ 

In  the  case  of  both  the  law  of  diminishing  utility  and 
that  of  diminishing  returns,  also,  there  are  maxima  to  be,,  rHtl 
taken  into  account  beyond  which  the  good  or  agency  ceases  sc** 
to  enter  into  problems  of  conduct  at  all,  becoming  a  "free  JJ^< 
good"  —  better  called  a  potential  good,  as  we  have  seen. 
The  correct  procedure  is  of  course  to  treat  superabundant 
elements  in  production  as  we  did  those  in  consumption; 
i.e.,  to  take  them  absolutely  for  granted  and  ignore  them 
completely.   Only  the  "possibility"  of  a  situation  arising 
in  which  a  thing  would  not  be  superabundant  can  give  it 
significance  or  lead  to  its  being  consciously  considered  in 
any  way.  ^ 

In  discussing  the  principle  of  diminishing  returns  a 
special  difficulty  arises  in  the  confusion  of  varying  propor- 
tions in  a  combination  with  changes  in  the  absolute  size 


98  RISK,  UNCERTAINTY,  AND  PROFIT 

of  the  combination  as  a  whole.  These  things  must  im- 
peratively be  kept  separate;  in  the  writer's  opinion  more 
error  has  arisen  over  this  point  than  any  other  single 
matter  in  distributive  theory.  If  the  amounts  of  all  ele- 
ments in  a  combination  were  freely  variable  without  limit 
and  the  product  also  continuously  divisible,  it  is  evident 
that  one  size  of  combination  would  be  precisely  similar  in 
its  workings  to  any  other  similarly  composed.  But  under 
this  condition  the  tendency  to  monopoly  in  the  production 
of  every  good  would  be  unimpeded.  For  the  competitive 
system  to  work,  it  is  necessary  to  postulate  that  the  con- 

f  ditions  as  to  divisibility  of  factors  are  such  that  the  bar- 
gaining unit  of  any  one  factor  is  quite  small  in  relation  to 
the  total  stock  of  agencies  which  more  or  less  effectively 
compete  with  that  unit,  and  also  that  an  establishment  of 
relatively  small  size  in  proportion  to  the  industry  as  a 
whole  is  more  efficient  than  a  larger  one.  Under  these  con- 

•  ditions  the  first  effect  of  competition  must  be  to  bring  all 
the  plants  within  an  industry  to  the  most  economical  size, 
and  leave  a  sufficient  number  in  operation  to  compete 
effectively  for  the  productive  agencies  which  all  use.1 
£•  The  principle  of  diminishing  returns  in  its  now  current 
form  runs  somewhat  as  follows:  As  successive  increments 
of  any  one  agency  are  added  to  fixed  amounts  of  other 

1  Competitive  relations  between  similar  establishments  are  much  com- 
plicated in  real  life  by  the  fact  that  practically  every  business  enjoys 
a  certain  degree  of  partial  monopoly.  It  does  not  turn  out  exactly  the 
same  product  (bundle  of  utilities)  as  its  competitors.  An  extreme  ex- 
ample is  the  case  of  railroads  where  a  part  of  the  output,  the  through 
traffic,  is  competitive  while  the  other  part,  the  local  traffic,  is  monopolis- 
tic. This  whole  question  of  the  relation  between  the  size  of  an  industry 
and  the  size  of  an  establishment  seems  to  the  writer  badly  mixed  up  in 
the  literature.  Professor  Bullock  has  distinguished  between  the  three 
principles  of  diminishing  returns  with  varying  proportions  between  the 
factors,  diminishing  costs  in  an  industry  as  a  whole  and  decreasing  costs 
in  the  single  establishment,  or  economy  of  large-scale  production.  (Cf. 
Quarterly  Journal  of  Economics,  vol.  xvr,  pp.  473  ff.)  But  no  one,  so  far 
as  I  know,  has  worked  out  these  cost  laws  adequately.  (Cf.  also  Daven- 
port, Economics  of  Enterprise,  chap.  xxiv).  Davenport  does  not  go  as 
far  as  Bullock  in  the  analysis  of  the  problem. 


JOINT  PRODUCTION  AND  CAPITALIZATION     99  , 

agencies  in  a  combination,  the  physical  product  of  the 

combination  will  increase,  but  after  a  certain  point  the 

output  will  increase  in  less  proportion  than  that  of  the 

agency  in  question  and  will  ultimately  decrease  absolutely.  x3 

A  more  general  formulation,  emphasizing  the  reference  to 

proportionality  in  contrast  with  absolute  size,  and  the 

reversibility  of  the  law,  might  run  as  follows:  When  the 

proportion  of  agencies  in  a  combination  is  continuously 

.  varied  over  a  very  wide  range,  there  is  generally  a  first 

,  stage  in  which  the  product  per  unit  of  either  agency  in- 

,  creases;  then  a  stage  in  which  the  product  per  unit  of  the 

,  relatively  increased  agency  decreases  and  the  product  per 

.  unit  of  the  relatively  decreased  agency  increases ;  and  finally 

.  a  third  stage  in  which  the  product  relative  to  either  agency 

decreases.  Since  either  agency  may  be  the  increasing  and 

•  the  other  the  decreasing  one,  the  first  and  third  stages  are 

•  identical  in  meaning.2 

1  See  F.  M.  Taylor,  Principles  of  Economics,  chap,  iv,  for  a  very 
thorough  and  sound  non-mathematical  discussion  of  the  whole  question 
of  variable  proportions  and  diminishing  returns.  I  must  remark,  how- 
ever, that  Taylor's  treatment  of  the  economy  of  large-scale  production 
seems  to  me  to  be  based  on  fallacy. 

2  The  second  statement  of  the  law  is  deducible  from  the  first.  All 
that  is  involved  in  the  law  of  diminishing  returns  is  properly  to  be  re- 
garded as  a  deduction  from  the  following  self-evident  premises: 

1.  The  proportions  of  agencies  in  a  combination  may  be  varied  without 
destroying  its  productivity. 

2.  If  to  a  certain  amount  of  one  agency  (say,  labor)  another  agency 
(say,  land)  is  added  in  amounts  varying  continuously  from  zero  to  in- 
finity, a  definite  amount  or  range  of  amounts  of  this  second  agency 
(neither  zero  nor  infinity)  will  yield  a  larger  total  product  than  will  larger 
or  smaller  amounts.  In  other  words,  if  the  proportion  of  one  agency  to 
another  is  increased  without  limit,  the  product  per  unit  of  the  decreasing 
agency  will  first  increase  and  then  decrease;  i.e.,  there  is  a  maximum 
point,  or  range,  beyond  which  in  either  direction  the  product  (per  unit 
of  the  increasing  agency)  will  decrease. 

3.  It  is  demonstrably  true,  and  is  necessary  to  the  theory  of  distribu- 
tion that  extreme  variation  (short  of  infinity)  in  either  direction  will 
yield  a  zero  product. 

It  is  most  essential  in  regard  to  this  law  that  it  relate  to  any  variation 
in  proportions  irrespective  of  the  absolute  amount  of  any  factor  present 
and  of  the  direction  of  the  change.  But  the  conventional  case  of  the  ap- 


100  RISK,  UNCERTAINTY,  AND  PROFIT 

It  is  requisite  for  an  intelligent  organization  of  produc- 
tion and  a  determinate  division  of  the  produce  among  the 
factors  by  competitive  price  forces  that  not  merely  the 
product  increase  in  less  ratio  than  the  factor,  but  that  equal 
arithmetic  increments  of  factor  yield  decreasing  incre- 
ments of  product.  These  two  principles  have  entirely 
different  meanings,  of  course,  but  they  are  badly  confused 
in  many  statements  of  the  theory  of  diminishing  returns. 
The  second  can,  however,  be  deduced  from  the  first,  which 
follows  from  the  very  nature  of  an  economic  situation,  as 
shown  below.  The  relations  of  the  various  elements  in  the 
problem  can  best  be  shown  by  reference  to  a  graph.  In  the 
accompanying  figure,  the  horizontal  or  X  distances  repre- 
sent quantities  of  the  single  variable  productive  factor  in  a 


J4i 

7* 


w 


/ 


w 


z 


plication  of  labor  to  land,  or  rather  of  land  to  labor,  is  easy  to  visualize 
and  suitable  for  illustration.  Let  us  imagine  a  group  of  new  settlers  on  a 
virgin  continent  faced  with  the  problem  of  how  much  of  the  unlimited 
supply  of  land  to  use  with  their  limited  supply  of  labor.  It  is  surely  evi- 
dent: (1)  that  they  can  use  different  amounts  and  still  get  some  product 
(Ax.  1) ;  (2)  that  they  can  use  too  little  or  too  much  to  get  the  largest 
amount  of  product  (Ax.  2) ;  (3)  that  they  might  conceivably  try  to  use  so 
little  or  so  much  land  that  no  product  at  all  would  be  secured  (Ax.  3). 


JOINT  PRODUCTION  AND  CA±>ITAJ.IZA;I:JON-    101 

combination,  and  the  vertical  or  Y  distances,  the  corre- 
sponding total  physical  output  of  the  group.  In  graphic 
terms  the  point  where  diminishing  returns  begin  is  the 
point  (3)  where  this  curve  becomes  tangent  to  a  straight 
line  through  the  origin.  Less  than  this  proportion  of  the 
variable  agent  cannot  intelligently  be  employed  even  if  it 
is  free,  for  the  output  could  be  increased  by  discarding  a 
portion  of  the  other  factors,  if  no  more  of  the  variable  one 
could  be  obtained  at  a  uniform  price.  It  is  true,  necessarily 
and  a  priori,  that  there  is  such  a  point  on  the  curve,  that  for 
less  amounts  the  product  increases  in  greater  ratio  than 
the  factor.  That  is,  for  any  point  on  the  curve  between  this 
point  (3)  and  the  intersection  of  the  curve  with  the  X 
axis  the  tangent  must  cut  the  X  axis  positively.  Now,  if 
below  this  point  (3)  the  tangent  to  the  curve  cuts  the  posi- 
tive X  axis,  if  at  this  point  it  passes  through  the  origin  and 
beyond  this  point  it  cuts  the  positive  Y  axis,  then  mani- 
festly the  curve  is  concave  downward  at  the  point  in 
question.  And  this  is  the  graphic  condition  representing 
decreasing  increments  of  product.  It  seems  reasonable  to 
assume  that  the  same  condition  (concavity  downward) 
holds  from  point  3  to  the  maximum  point  (4),  but  this  is 
not  demonstrable  a  priori.  If  it  is  untrue  for  a  certain  stage 
in  this  interval  between  points  3  and  4  over  the  whole  field 
of  industry,  as  represented  by  the  dotted  line  in  the  figure, 
there  is  indeterminateness  in  the  competitive  situation  in 
that  interval  and  to  that  extent,  but  this  is  a  rather  in- 
credible supposition. 

It  is  immaterial  what  shape  the  curve  has  below  point  3 
so  long  as  its  tangent  always  cuts  the  X  axis.  No  doubt  in 
any  one  industry  the  curve  will  show  stages  of  increasing 
returns  interspersed  with  stages  of  decreasing  returns,  and 
various  proportions  of  combination  of  the  factors  are  wise 
and  stable.1 

1  It  is  to  be  noted  that  we  must  assume  the  size  of  individual  establish- 
ments to  be  nearly  a  matter  of  indifference. 
The  above  reasoning  proves  also  that  the  curve  itself  cuts  the  X  axis 


102  EISK;  UNCERTAINTY,  AND  PROFIT 

If  men  are  supposed  to  know  what  they  are  doing  there 
is  no  occasion  for  discussing  the  first  and  third  stages  at  all. 
The  boundaries  of  the  second  stage  represent  extreme 
limits  where  one  agency  or  the  other  becomes  a  free  good 
and  passes  out  of  consideration  altogether.  Beyond  this 
point  the  product  is  absolutely  diminished  by  increasing 
one  agency  or  the  other,  as  the  case  may  be,  which  is  an 
absurdity.  The  identity  in  meaning  of  the  first  and  the 
third  stages  is  evident;  the  first  stage  when  passing  in  one 
direction  is  the  third  when  reading  the  data  in  the  opposite 
order.  It  is  a  mere  matter  of  the  arrangement  of  results, 
not  of  the  results  themselves.  Beyond  the  limits  of  the 
stage  of  "decreasing  returns,"  therefore,  or  under  cir- 
cumstances where  the  law  did  not  hold,  there  could  not 
exist  an  "economic"  situation.  Unless  the  return  per  unit 
of  any  agency  does  decrease  it  is  not  productive  at  all;  its 
use  adds  nothing  to  the  output  of  the  combination.  If  we 
imagine  increasing  returns  the  agency  is  negatively  pro- 
ductive. This  fact  has  been  recognized  in  the  case  of  land 
in  the  common  statement  that  additional  land  would 
never  be  taken  up  until  diminishing  returns  set  in  on  that 1 
already  in  use. 

The  facts  of  variability  in  the  proportions  of  agencies  in 

the  productive  organization,  and  of  the  variation  of  the 

yield  relative  to  the  different  agencies  in  accordance  with 

the  principle  of  diminishing  returns  not  merely  make 

positively  as  drawn  in  our  figure,  and  does  not  pass  through  the  origin. 
It  follows  further  from  the  symmetry  of  the  relation  between  factors  that 
the  curve  will  cut  the  X  axis  again  beyond  the  maximum  point  and  not 
become  asymptotic,  as  it  should  do  if  it  passed  through  the  origin.  Pro- 
fessor Taylor's  curve  was  incorrectly  drawn  in  this  detail  as  it  should 
either  become  asymptotic  or  else  not  pass  through  the  origin. 

1  Really  on  the  other  agencies  applied  to  the  land,  but  we  follow  the 
usual  formulation.  The  assumption  must  be  borne  in  mind  that  men 
know  what  they  are  doing  and  are  motivated  by  the  desire  to  maximize 
production.  In  fact,  the  results  are  much  distorted  by  ignorance,  the 
effect  of  tradition  carried  over  from  a  place  where  land  is  scarce  to  new 
countries  where  it  is  abundant,  ingrained  land  hunger,  etc.,  and  in  the 
United  States  by  the  conditions  of  land  settlement  and  preemption. 


JOINT  PRODUCTION  AND  CAPITALIZATION    103 

possible  the  economic  organization  of  society  through  free 
contract,  but  in  their  absence  the  whole  question  of  or- 
ganization would  be  meaningless;  there  would  be  no  such 
problem.  Unless  there  were  open  for  use  various  com- 
binations of  various  productivities,  with  the  possibility  of 
comparing  them,  there  would  be  no  question  of  using  any 
one  arrangement  rather  than  any  other.  Organization  is 
called  for,  is  possible,  and  is  carried  out  only  through  the 
fact  that  the  separate  contributions  of  separate  agencies  to 
a  joint  product  can  be  identified.  The  organization  through 
free  contract  under  competition  is  possible  and  real  and 
effective  in  so  far  as  such  a  system  tends  to  give  to  the 
owner  of  each  agency  the  separate  contribution  of  that 
agency.  Modern  society  is  organized  through  the  associa- 
tion of  control  over  productive  agencies  with  the  right  to 
their  yield.  Only  because  the  income  is  greater  where  the 
product  is  larger  is  such  organization  possible  at  all.  In  the 
absence  of  a  law  connecting  distributive  share  with  effective 
contribution  our  social  system  would  be  no  system,  but 
chaos.  It  is,  therefore,  inappropriate  for  economists  to  argue 
as  to  whether  the  separation  of  contributions  to  a  joint 
product  can  or  cannot  be  made;  it  is  made;  it  is  our  business 
to  explain  the  mechanism  by  which  it  is  accomplished. 

The  business  man  does  find  out  how  much  different 
agencies  or  units  of  productive  power  are  worth  to  the  pro- 
ductive process  or  he  could  not  carry  on  his  business.  It 
is  obvious  that  the  business  man,  in  bidding  for  the  use  of 
separate  agencies,  must  think  in  terms  of  the  added  con- 
tributions of  added  units,  —  in  technical  economic  par- 
lance the  " marginal' '  product,  —  and  it  is  demonstrable 
that  when  the  units  are  sufficiently  small  the  sum  of  the 
separate,  specific  contribution  of  all  the  agencies  exhausts 
the  total  joint  product.1 

It  is  to  be  observed  that  when  a  new  productive  unit  is 
added  to  a  productive  combination  the  technical  law  of 
1  Cf.  below,  p.  108  and  note. 


104  RISK,  UNCERTAINTY,  AND  PROFIT 

diminishing  returns  does  not  fully  describe  the  variation  in 
the  output.  In  consequence  of  this  law  alone,  the  added 
physical  product  of  similar  agencies  will  rise  in  the  position 
from  which  the  one  in  question  is  withdrawn  and  fall  in 
that  into  which  it  moves.1  But  in  addition,  since  the  trans- 
fer decreases  the  total  output  of  the  commodity  from  whose 
production  the  agency  is  withdrawn,  and  increases  the  out- 
put of  the  industry  into  which  it  is  moved,  the  price  of  the 
former  will  rise  and  of  the  latter  fall  relatively.  In  an  or- 
ganized free  exchange  society,  producers  naturally  estimate 
product  in  terms  of  its  exchange  value  and  not  of  its 
physical  magnitude.  The  variations  in  physical  contribu- 
tion and  in  the  value  of  that  contribution  when  an  addition 
of  any  kind  of  agency  is  made,  work  in  the  same  direction 
and  must  be  added  to  give  the  total  decrease  in  the  value 
product.  We  shall  call  the  aggregate  variation  by  the  name 
of  diminishing  value  productivity  or  simply  diminishing 
'productivity,  which  must  always  be  distinguished  from  the 
diminishing  physical  returns.2 

1  The  fall  in  specific  or  marginal  contribution  is  an  easy  inference  from 
the  law  of  the  variation  of  product  per  unit..  For  a  detailed  demonstration 
see  Taylor,  loc  dt.t  especially  pp.  101,  102.  The  "added  product"  of  a 
unit  in  the  text  above  is  what  Taylor  and  most  writers  call  "the  marginal 
product"  of  the  "factor."  For  reasons  which  will  presently  appear  I 
prefer  to  avoid  the  misleading  terminology  of  factors  and  margins  al- 
together. 

2  This  terminology  is  more  or  less  arbitrary,  but  is  one  way  of  straight- 
ening out  the  current  confusion  and  giving  different  names  to  different 
things.  Taylor  (loc.  cit.)  uses  both  expressions  "diminishing  returns"  and 
"diminishing  productivity,"  in  connection  with  the  instrumental  law; 
in  fact  in  virtually  the  same  sense,  and  does  not  bring  out  the  contrast 
between  the  variation  of  physical  product  and  that  of  value  product. 
Strange  to  say,  he  does  not  use  the  principle  of  diminishing  returns  which 
he  so  well  formulates  in  his  discussion  of  distribution,  but  adopts  a 
different  line  of  reasoning  through  different  proportions  of  factors  in 
different  industries  without  variability  of  proportions  in  single  industries. 
That  this  same  principle  is  involved  is  recognized  by  Taylor,  who  thus 
shows  a  considerable  advance  over  Wieser.  This  author,  it  will  be  recalled, 
uses  the  same  theory  of  imputation  which  Taylor  uses,  but  advances  it  in 
place  of  the  specific  productivity  theory,  applied  to  industries  independ- 
ently, which  he  repudiates.  (See  below,  p.  110.) 


JOINT  PRODUCTION  AND  CAPITALIZATION    105 

It  is  unnecessary  to  introduce  into  our  society  any  factors 
or  agencies  other  than  labor  in  order  to  study  the  mechan- 
ism of  imputation.  Groups  of  individuals  more  or  less 
specialized  to  and  specializing  in  different  productive 
functions  in  the  making  of  the  same  commodity  represent 
in  principle  all  that  is  involved  in  the  cooperation  of  agen- 
cies of  whatever  difference  in  nature.  We  may,  therefore, 
refer  to  these  different  functionaries  as  types  of  agencies, 
or  indeed  as  "factors"  of  production,  though  we  shall 
presently  find  reasons  for  avoiding  this  term,  on  account 
of  its  misleading  connotations.  When  the  conditions  of  a 
"static"  society  —  i.e.,  given  conditions  of  the  production 
and  consumption  of  goods  —  are  correctly  laid  down,  there 
is,  as  we  have  seen,  no  room  for  property  in  any  sense 
which  differentiates  it  from  productive  capacities  inherent 
in  the  person  of  the  owner.1 

This  matter  will  be  discussed  at  greater  length  as  we 
proceed.  Let  it  merely  be  understood  at  this  point  that  any 
class  or  group  of  agencies,  or  "factor"  of  production  to 
which  we  refer,  is  formed  on  the  basis  of  the  physical  facts 
and  includes  those  things  which  are  actually  interchange- 
able one  with  another  in  the  production  process.  If  we 
speak  of  "factors "  at  all,  there  will  thus  be  not  three,  but  a 
quite  indefinitely  large  number  of  them.2 

As  a  matter  of  fact,  a  great  deal  of  unnecessary  mysti- 
fication has  been  thrown  around  the  problem  of  imputa- 
tion. It  is  merely  a  case  of  joint  demand,  and  the  same 
situation  is  common  in  the  case  of  consumption  goods. 
There  is  really  no  more  mystery  or  special  difficulty  about 
separating  the  demand  for  labor  or  any  particular  kind  of 
labor,  due  to  the  fact  that  it  is  not  employed  alone,  than 
there  is  about  constructing  a  separate  demand  curve  for 
butter,  which  is  always  consumed  along  with  other  com- 

1  Cf.  above,  chapter  in. 

2  As  Davenport  has  remarked.  (Cf.  Economics  of  Enterprise,  chap. 
xxii.)  But  Davenport's  position  will  come  up  for  criticism  later  on. 
(Below,  p.  124.) 


106  RISK,  UNCERTAINTY,  AND  PROFIT 

modities.  The  principle  of  variable  proportions  is  the  key 
to  the  solution  in  both  cases.  Commodities  always  used 
together  and  always  in  the  same  proportions  would  not  be 
separate  commodities,  as  far  as  consumption  is  concerned, 
but  parts  of  one  commodity,  though  they  might  still  be 
valued  separately  if  the  conditions  of  production  were  dis- 
tinct. 

Keeping  in  mind  the  above  facts  and  the  simplified  con- 
ditions under  which  we  are  working,  it  is  not  difficult  to 
picture  the  actual  mechanism  of  the  organization.  Let  us 
begin  as  in  the  last  chapter  with  a  random  adjustment  and 
follow  through  the  successive  readjustments  to  the  equi- 
librium condition.  Suppose  that  groups  of  producers  are 
formed  by  guess  in  any  chance  way,  the  product  of  each 
group  as  a  whole  being  determined  in  the  manner  already 
described  and  its  division  among  the  members  of  the  group 
arranged  on  any  basis  whatever.  It  is  evident  that  the 
desire  of  every  individual  to  better  himself  will  lead  at 
once  to  three  sorts  of  inquiries.  cFirst,  each  person  will 
endeavor  to  ascertain  his  own  value  to  the  group  of  which 
he  is  a  member  and  compare  it  with  the  share  which  he  is 
receiving;  and  second,  he  will  similarly  inquire  what  he 
*  might  be  worth  to  other  groups.  Third,  as  a  member  of  a 
group  each  individual  will  interest  himself  in  the  value  to 
the  group  of  other  individuals  in  it  and  in  the  value  which 
individuals  outside  it  would  have  if  they  could  be  pro- 
r  cured  for  his  group.  As  a  result,  (1)  remunerations  will 
^•rapidly  be  readjusted  toward  the  values  which  the  individ- 
uals contribute  to  the  output  of  the  groups  with  which  they 
^  work,  and  (2)  all  individuals  will  gravitate  toward  those 
groups  in  which  they  can  make  the  largest  contributions  to 
output.  Any  individual  receiving  from  his  group  more 
than  he  is  worth  will  be  released  or  have  his  remuneration 
reduced.  Any  individual  receiving  less  than  he  is  worth 
will  be  able  to  secure  his  full  value,1  since  we  have  specified 
1  The  mode  of  internal  organization  of  the  groups  need  not  trouble  us 


JOINT  PRODUCTION  AND  CAPITALIZATION    107 

conditions  under  which  perfect  competition  will  exist 
between  the  groups.  3 

All  productive  groups  would  thus  compete  among  them- 
selves for  the  services  of  actual  and  potential  members,  and 
the  individuals  in  the  society  would  compete  for  positions 
in  the  group  in  a  manner  quite  analogous  to  the  existing 
order  of  things.cThe  standard  of  what  a  group  could  afford 
to  pay  for  a  man  is  clearly  the  amount  which  he  enables  it 
to  produce  more  than  it  would  produce  without  him.  In 
the  final  adjustment  the  individual's  contribution  to  the 
income  of  the  group  is  his  contribution  to  the  income  of 
society  as  a  whole,  which  he  is  under  pressure  to  make  as 
large  as  possible  by  placing  himself  in  the  position  where  he 
is  really  most  effective.1.!  The  tendency  of  a  competitive 

here.  It  might  take  any  form  which  would  produce  effective  common 
action  and  responsibility.  In  life,  it  is,  of  course,  generally  worked  out 
through  a  responsible  entrepreneur  as  intermediary,  but  it  is  necessary 
to  exclude  such  a  functionary  at  this  point  in  the  argument,  and  in  fact 
his  services  would  be  superfluous,  except,  perhaps,  temporarily  while  the 
adjustment  was  being  worked  out.  Greater  violence  is  done  to  reality  by 
the  specification  of  perfect  competition  among  organizations  for  members. 
This  assumption  involves,  in  the  first  place,  perfect  knowledge  and  inter- 
communication throughout  the  society.  In  addition  it  calls  for  a  large 
number  of  groups  exploiting  every  sort  of  service,  and  entire  absence  of 
collusive  action  among  them.  The  number  of  establishments  in  any  line 
of  production  depends  upon  the  size  of  each,  which  in  turn  depends  on  the 
divisibility  of  the  factors  being  combined.  Hence  the  principle  laid  down 
above  (p.  98)  that  competition  depends  on  a  degree  of  divisibility  in 
productive  factors.  That  division  of  labor  is  limited  by  the  scope  of  the 
market  is  true,  but  commodities  sold  in  different  markets  do  not  repre- 
sent the  same  aggregations  of  utilities,  and  are  different  commodities. 

1  There  is  a  difficulty  in  regard  to  the  meaning  of  the  value  contribution 
to  a  social  total.  Exchange  values  being  essentially  ratios,  an  aggregate  of 
exchange  value  has  very  little  meaning.  We  cannot  be  sure  that  the  value 
income  of  society  as  measured  by  the  market,  in  terms,  say,  of  a  particular 
commodity,  would  be  larger  when  the  final  adjustment  was  reached  than 
under  any  other  arrangement,  and,  of  course,  it  will  not  do  to  say  that  the 
individual  gets  the  physical  commodities  which  he  enables  the  society  to 
produce.  The  answer  is  that  he  will  get  the  value  of  the  physical  contri- 
bution which  he  makes,  enough  value  income  to  buy  it.  The  actual 
physical  contribution  should  theoretically  consist  of  infinitesimal  incre- 
ments of  practically  all  the  commodities  produced  in  the  society,  perhaps 
including  an  increment  of  "leisure.". 


108  RISK,  UNCERTAINTY,  AND  PROFIT 

organization  is,  therefore,  toward  that  ideal  adjustment 
familiar  in  the  literature  of  laissez-faire.  In  the  final  ad- 
justment the  organization  could  not  be  changed  without 
bringing  uncompensated  losses,  and  the  total  produce 
would  be  divided  among  all  claimants  by  giving  each  his 
added  product.1 

The  conditions  precedent  to  this  theoretical  result  are 
indeed  abstract;  but  they  are  the  conditions  of  perfect  com- 
petition, and  they  are  the  conditions  which  actual  society 
more  or  less  closely  approaches.  It  is  important  both  to 
understand  free  competition  because  society  does  approach 
S  it  more  or  less  closely  as  an  ideal,  and  to  be  fully  aware  of  the 
artificiality  of  the  conditions  necessary  to  realize  it  perfectly. 

Another  way  of  formulating  the  condition  of  equlibrium 
is  to  view  the  adjustment  as  a  continual  repricing  of  pro- 
ductive services.  This  process  would  be  more  closely  analo- 
gous to  the  process  by  which  the  prices  of  consumption 
goods  are  determined.  We  can  think  of  each  producer  or 
group  as  being  in  the  market  with  a  certain  amount  of 
money  to  spend  for  productive  power  in  the  abstract.  At 
the  price  level  established  at  any  moment  those  productive 
agencies  will,  of  course,  be  purchased  which  make  the 
largest  price  contribution  to  product  for  a  given  price 
outlay.  But  since  the  amounts  of  all  agencies  in  existence 
are  fixed,  competition  will  quickly  force  a  readjustment  of 
prices  to  that  point  at  which  equal  price  amounts  of  all 
agencies  make  equal  price  contributions  to  product,  just  as 
in  the  former  case  equal  price  amounts  of  all  goods  must 

1  For  a  full  discussion  and  demonstration  of  the  theoretical  exhaustive- 
ness  of  the  distributive  process  as  described  above  (though  in  a  somewhat 
different  setting),  see  Wicksteed,  Common  Sense  of  Political  Economy, 
book  ii,  chap,  vi,  and  The  Coordination  of  the  Laws  of  Distribution, 
Pflssim.  The  reader  will  notice  that  the  lines  along  which  the  adjust- 
ment is  supposed  to  be  worked  out  above  are  very  different  from  the 
"dosing  method"  familiar  in  American  economic  literature.  (Cf.  espe- 
cially J.  B.  Clark,  The  Distribution  of  Wealth,  chap,  xii.)  This  latter 
procedure  seems  to  the  writer  unnecessarily  abstract  and  unreal  and  more 
difficult  to  follow  than  the  realistic  method  of  tracing  out  the  effect  of 
competition  among  establishments. 


JOINT  PRODUCTION  AND  CAPITALIZATION    109 

represent  "equal  utilities"  to  all  consumers.  The  organiza- 
tion of  the  productive  system  as  a  whole  is  in  fact  quite 
analogous  to  that  of  the  expenditure  of  income.  Productive 
agencies  are  now  the  given  resources  of  which  the  best  use 
is  to  be  made  by  distributing  them  so  as  to  secure  equality 
of  remuneration  for  similar  units  in  all  employments.  In 
the  organization  as  a  whole,  the  two  principles  combine. 
The  money  income  may  be  omitted,  as  an  instrumental 
intermediary,  andcthe  result  stated  by  saying  that  the  real 
resources  of  society  tend  to  be  so  distributed  among  all  em-  v^~- 
ployments  that  similar  physical  units  everywhere  make 
contributions  psychically  equivalent  to  all  persons  in  the 
system  in  a  position  to  choose  between  them.3 

It  will  now  be  in  order  to  notice  the  more  important  ob- 
jections which  have  been  made  to  the  productivity  theory 
of  distribution,  though  many  or  all  of  them  have  already 
been  answered  and  probably  would  not  be  made  against  the 
form  of  the  theory  presented  above.  To  begin  with,  let  us 
insist  on  the  complete  separation  of  the  theory  of  distribu- 
tion proper  from  certain  sweeping  moral  and  social  dog- 
mas, which  have  been  deduced  from  it.  Professor  J.  B. 
Clark,  the  leading  American  exponent  of  the  theory,  is 
partly  responsible  for  this  confusion,  through  a  few  un- 
guarded paragraphs  in  "The  Distribution  of  Wealth."1 
The  illegitimacy  of  these  ethical  deductions  has  been  well 
argued,  however,  by  Professor  Carver,2  another  expositor 
of  the  theory,  as  well  as  by  Professor  J.  M.  Clark  in  de- 
fending the  theory  itself.3  We  may,  therefore,  pass  over  the 
strictures  of  those  writers  who  do  not  like  social  implica-  mH* 
tions  which  the  theory  does  not  have,  which  include  a  y  • 
considerable  part  of  the  criticism  of  Professors  Daven-  £^» 
port4  and  Adriance;5  we  shall  take  up  briefly  the  ques-  ^ 

1  See  especially  pp.  8,  9. 

2  Quarterly  Journal  of  Economics,  August,  1901. 
8  Political  Science  Quarterly,  June,  1915. 

4  The  Economics  of  Enterprise,  chap.  x. 

5  "Specific  Productivity,"  Quarterly  Journal  of  Economics,  vol.  xxix, 
pp.  149  ff.,  esp.  pp.  159  and  160. 


110  RISK,  UNCERTAINTY,  AND  PROFIT 

tion  of  the  ethical  aspects  of  the  competitive  system  in 
chapter  vi. 

Against  the  productivity  theory  itself  an  old  and  com- 
mon criticism  is  that  well  stated  by  Wieser,1  who  attempts 
to  refute  Menger's  presentation  of  it,  and  substantially 
the  same  line  of  attack  has  been  followed  more  recently 
by  Hobson,2  who  refers  especially  to  Wicksteed.  The  con- 
tention is  that  specific  or  marginal  productivity  cannot 
afford  a  theoretically  adequate  method  of  distribution,  for 
the  reason  that  the  sum  of  the  products  of  the  separate 
agencies,  as  defined  by  the  theory,  will  be  not  equal  to  the 
total  joint  product,  but  considerably  larger.  The  amount 
subtracted  from  the  total  product  when  "one  unit"  is 
withdrawn  will,  it  is  argued,  be  much  greater  than  can 
be  imputed  to  that  agent  alone,  since  the  loss  of  any  agent 
will  more  or  less  dislocate  the  organization.  It,  therefore, 
becomes  impossible  by  this  method  to  divide  the  total  ac- 
curately into  parts  ascribable  to  the  separate  "factors" 
individually  as  the  specific  contribution  of  each.  Wieser 
proposes  an  alternative  method,  which  is  identical  with 
Professor  F.  M.  Taylor's  exposition  of  the  productivity 
theory  itself.8  Hobson  dogmatically  declares  the  problem 
impossible. 

The  error  in  this  line  of  reasoning  lies  in  fixing  the 
attention  upon  a  comparatively  small  organization  and 
comparatively  large  blocks  or  units  of  productive  service. 
When  account  is  taken  of  the  actual  size  of  industrial 

1  Der  Natiirliche  Werth,  3.  Abschnitt,  "Die  Nattirliche  Zurenchnung 
des  Productiven  Ertrages,"  §  22. 

2  The  Industrial  System,  chap,  v,  appendix,  pp.  112-20.  A  somewhat 
different  (quasi-mathematical)  line  of  argument  to  the  same  end  is  put 
forth  by  R.  S.  Padan,  Journal  of  Political  Economy,  March,  1901  (vol.  ix, 
pp.  161  ff.). 

8  Cf.  above,  p.  104,  note.  Taylor  is  right  in  the  contention  that  specific 
productivity  can  be  imputed  through  differences  in  the  proportions  of 
agencies  in  different  industries  alone  without  variability  of  proportions  in 
the  industries  individually.  In  fact,  both  elements  come  into  play.  We 
have  mentioned  and  shall  presently  discuss  further  the  fallacy  involved 
in  the  concept  of  the  "factor"  of  production. 


JOINT  PRODUCTION  AND  CAPITALIZATION    111 

society  and  of  the  ordinary  unit  of  most  agencies,  it  will 
be  seen  that  the  "dislocation"  is  negligible;  theoretically, 
to  be  sure,  the  units  would  have  to  be  of  infinitesimal 
size,  separately  owned  and  effectively  competing;  i.e.,  the 
proportions  must  be  continuously  variable,  in  the  mathe- 
matical sense.  But  in  the  typical  case  the  error  resulting 
from  this  assumption  is  not  large  in  comparison  with  other 
inaccuracies  in  the  competitive  adjustment.  It  is  true  that 
there  are  exceptional  cases  where  agencies  are  not  highly 
divisible,  or  even  not  divisible  at  all,  and  competition  gives 
place  to  a  greater  or  less  degree  of  monopoly.  These  ex- 
ceptions are  relatively  infrequent  in  the  mass  of  industry 
as  a  whole,  but  are  of  considerable  absolute  importance,  and 
we  shall  have  something  to  say  later  on  in  regard  to  unique 
and  indivisible  agencies.1 

Padan,  in  the  article  referred  to,  further  attacks  Pro- 
fessor Clark's  exposition  of  the  productivity  theory  on  the 
express  ground  that  the  amount  received  by  any  factor 
would  depend  on  the  arbitrary  size  assigned  to  the  marginal 
unit.  This  point  also  is  hypothetically  sound,  but  irrelevant. 
The  size  of  the  unit  is  not  an  arbitrary  matter  of  method- 
ology, but  a  question  of  fact,  and  Professor  Clark  may  be 
open  to  criticism  only  for  seeming  to  imply  the  contrary. 
The  soundness  of  the  theory,  the  possibility  of  competitive 
distribution  at  all,  in  fact,  depends  on  the  actual  division  of 
productive  agencies  into  bargaining  units  of  small  size.2 

1  See  chapter  vi. 

2  We  may  notice  here  another  point  raised  by  Padan,  the  bearing  of 
increasing  returns  upon  the  theory.  It  is  generally  recognized  that  in  the 
earlier  stages  of  a  hypothetical  dosing  process,  increasing  returns  will  be 
secured,  up  to  a  certain  point.  By  "supposing"  this  stage  of  increasing 
returns  to  last  throughout  the  process,  Padan  easily  makes  the  applica- 
tion of  the  method  appear  absurd.  This  line  of  reasoning  is  still  more 
arbitrary  than  his  earlier  point,  however,  and  need  not  detain  us.  We  have 
shown  at  sufficient  length  that  increasing  returns  is  an  absurdity;  that  an 
agency  worked  under  such  conditions  is  negatively  productive  and  had 
better  not  be  used  at  all.  Professor  A.  Landry,  in  criticizing  Professor 
Carver,  has  also  overworked  this  supposition.  (See  Quarterly  Journal  of 
Economics,  vol.  xxm,  pp.  557  ff.) 


112  RISK,  UNCERTAINTY,  AND  PROFIT 

We  should  hold  that  it  is  an  error  to  say  that  "labor" 
or  any  "factor"  gets  or  tends  to  get  its  product.  This 
holds  good  only  for  the  actual  individual  men  or  other 
agencies. 

A  third,  somewhat  philosophical,  criticism  is  also  ad- 
vanced by  Davenport  and  Adriance.  It  is  contended  that 
the  "marginal"  product  of  labor,  for  example,  is  as  much  a 
joint  product  as  that  of  any  other  than  the  marginal  unit. 
The  laborer  who  uses  no-rent  land  still  has  to  use  it,  can 
produce  nothing  without  it,  and  hence  the  product  can- 
not be  ascribed  to  the  labor  alone.  Professor  Taussig  also, 
though  like  Davenport  somewhat  guardedly,  asserts  that 
all  product  is  joint  product  and  cannot  be  divided  into 
parcels  attributable  to  separate  agencies,  though  at  the 
same  time  he  inclines  to  regard  all  income  as  the  "pro- 
duct" of  labor.1  An  examination  of  this  reasoning  would 
carry  us  into  the  question  of  the  meaning  of  production 
and  causality,  which  will  be  taken  up  presently.  For  the 
present  it  must  suffice  to  point  out  that  it  involves  a 
confusion  between  mechanical  and  economic  productivity. 
The  land  used  by  marginal  labor  may  be  necessary  to  the 
operations  in  the  former  sense,  but  is  not  in  the  latter,  since 
by  hypothesis  if  it  is  withheld  from  use  it  can  at  once  be 
replaced  by  other  land  equally  good;  otherwise  it  would 
not  be  free  land.  The  fallacy  is  parallel  to  the  confusion 
between  "utility"  (as  usually  defined)  and  economic  value. 
Free  goods,  like  air,  may  be  necessary  to  life,  but  no  par- 
ticular portion  being  necessary,  the  good  cannot  have 
economic  value  (nor,  as  we  have  argued  above,  should  it  be 
said  to  have  utility  if  this  term  is  to  be  used  to  connote 
any  sort  of  economic  significance). 

We  must  notice,  finally,  another  objection  raised  by 

1  Proceedings,  Twenty-Second  Annual  Meeting  of  the  American 
Economic  Association,  p.  143.  Taussig's  statement  that  labor  produces 
all  wealth,  but  is  not  entitled  to  all  of  it,  would  better,  it  seems  to  me, 
be  reversed.  Labor  cannot  claim  to  be  the  only  causal  source  of  goods, 
but  may  put  forth  a  superficial  claim  to  a  right  to  consume  them  all. 


JOINT  PRODUCTION  AND  CAPITALIZATION    113 

Hobson  to  the  general  doctrine  of  "marginalism."  1  With 
Hobson's  fundamental  position,  that  marginalism  is  the 
necessary  form  of  a  rational  treatment  of  choice,  and  that 
the  rational  view  of  life  is  subject  to  drastic  limitations, 
the  writer  is  in  hearty  accord.  It  is  not  clear  that  Hobson 
intends  his  strictures  to  apply  specifically  to  the  productiv- 
ity theory  of  distribution,  but  it  may  not  be  out  of  place 
to  remark  that  such  an  application  would  be  an  error.  In 
general  we  submit  that  there  is  much  more  deliberate, 
quantitative  balancing  of  alternatives  in  economic  con- 
duct than  the  discussion  under  notice  would  have  us 
believe,  but  this  is  a  large  issue  which  cannot  be  threshed 
out  here.  It  does  not  seem  to  us  that  the  composition  of 
life  is  closely  analogous  to  Hobson's  painting  or  cake  in 
which  the  proportion  of  the  ingredients  is  rigidly  deter- 
mined by  a  recipe  or  a  preconceived  ideal  of  the  whole. 
In  any  case,  the  production  of  goods  by  industry  is  very 
emphatically  a  rational  process,  an  adjustment  worked 
out  by  the  producer  in  terms  of  these  very  separable  effects 
of  separate  agencies.  Nor  is  it  true,  as  Hobson  does  argue 
elsewhere,2  that  technical  conditions  prescribe  the  pro- 
portions in  which  agencies  are  to  be  used.  The  proportions 
of  labor  to  land  and  of  capital  to  either,  and  to  a  large  ex- 
tent of  various  sorts  of  each  among  themselves,  are  open 
to  variation  through  a  range  almost  without  technical 
limit,  in  the  fundamental  industries  at  least.  Again,  the 
final  appeal  is  to  fact.  It  is  the  value  to  the  producer  as  an 
addition  to  his  organization  as  a  whole  which  determines 
the  amount  which  he  will  bid  in  the  market  for  the  use  of 
any  unit  of  labor,  land,  or  capital,  or  the  amount  of  any  one 
which  he  will  purchase  at  an  established  price.  Hence  it  is 
this  "specific  product"  which  rules  the  apportionment  of 
income  at  large  among  productive  agencies  at  large. 
As  remarked  above,  most  of  the  objections  to  the  pro- 

1  Work  and  Wealth,  chap/  xxn. 

2  The  Industrial  System,  cited  above. 


114  RISK,  UNCERTAINTY,  AND  PROFIT 

ductivity  theory  relate  to  the  meaning  of  production  and 
of  product,  and  come  down  in  fine  to  the  propriety  of  using 
the  word,  rather  than  to  any  fundamental  disagreement  as 
to  how  the  distributive  mechanism  actually  works.  We 
wish  now  to  point  out  that  in  calling  the  addition  made  by 
any  agency  to  the  total  output  of  a  large  organization  its 
specific  or  separate  product,  we  are  using  the  word  "pro- 
duct" in  the  same  meaning  and  the  only  meaning  which 
the.  words  "cause"  and  "effect"  or  equivalent  terms 
ever  have.  It  is  never  true  in  an  absolute  sense  that  one 
event  is  the  cause  of  another.  The  whole  state  of  the 
universe  at  one  moment  may  perhaps  be  said  to  cause  its 
whole  state  at  the  next  moment,  but  when  we  say  that  "  A  " 
is  the  "cause"  of  "B"  we  always  assume  that  other  things 
are  equal;  we  never  mean  that  if  the  rest  of  the  universe 
were  removed  "A"  alone  would  produce  "B."  And  the 
imputation  of  any  single  event  to  another  as  cause  or 
effect  is  always  largely  arbitrary.  Every  event  has  an 
infinite  number  of  causes,  and  it  depends  upon  circum- 
stances, the  point  of  view,  the  problem  in  hand,  which  of 
these  we  single  out  for  designation  as  "The"  cause. 
"The"  cause  of  a  phenomenon  is  merely  that  one  of  its 
necessary  conditions  which  is  for  some  practical  reason 
crucial,  generally  from  the  standpoint  of  control.  It  is  the 
one  about  which  we  must  concern  ourselves,  the  circum- 
stances enabling  us  to  take  the  others  for  granted.*  It  may 
be  quite  correct  to  name  a  dozen  different  antecedents  as 
"the"  cause  of  a  particular  occurrence,  according  to  the 
point  of  view.  The  fact  that  other  agencies,  even  the 
whole  social  system,  may  be  concerned  in  the  production  of 
a  certain  good  does  not  therefore  argue  against  its  being 
the  (specific)  product  of  the  particular  agency  upon  whose 
activity  its  creation  actually  hinges  under  the  actual  cir- 
cumstances of  the  case.1 

1  In  the  writer's  opinion,  the  hostility  to  the  productivity  theory  is 
due  mainly  to  the  notion  that  the  productivity  of  labor  and  capital  repre- 


JOINT  PRODUCTION  AND  CAPITALIZATION    115 

A  general  analytic  statement  of  the  principles  of  static 
organization,  in  price  terms  and  on  the  basis  of  supply  and 
demand,  will  consist  of  two  main  parts.  We  have  to  con- 
sider two  valuation  problems  relating  respectively  to  con- 
sumption goods  and  productive  services.  The  problems, 
are  usually  designated  as  "value"  and  "distribution." 
It  will  be  convenient  to  take  up  the  second  of  these  prob- 
lems first.  We  have  already  seen  that  the  effective  form 
of  the  law  of  variation  of  proportions  of  factors  is  the  law  of 
diminishing  value  productivity.  It  is  obvious  that  all  re- 
adjustments involve  transfers  of  productive  resources  and 
that  every  such  transfer  implies  a  price  change,  raising  the 
prices  of  goods  produced  by  the  organization  from  which 
resources  are  taken  and  lowering  the  prices  of  goods  to 
whose  production  resources  are  diverted.  And  the  effect 
of  this  price  change  coincides  in  direction  with  the  effect  of 
diminishing  physical  returns.  We  may  content  ourselves 
for  the  present  with  this  superficial  view  of  the  price  re- 
actions on  the  side  of  consumption  goods  and  proceed  to 
work  out  the  price  conditions  of  equilibrium  of  the  system 
in  terms  of  the  distributive  shares.  After  which  the  view- 
point will  be  shifted  to  regard  these  shares,  not  as  the  re- 
munerations of  agencies,  but  as  costs  of  the  goods  into 
which  their  services  enter.  When  the  adjustment  and  its 
equilibrium  have  been  studied  as   a  relation   between 

sents  their  moral  desert  in  distribution,  joined  to  the  conviction  that  the 
existing  order  is  not  morally  ideal.  The  theorists  who  treat  a  productivity 
remuneration  as  synonymous  with  ideal  justice  are  merely  uncritically 
voicing  the  popular  view.  It  is  this  popular  dogma  which  is  the  seat  of 
the  difficulty,  and  which  represents  a  confusion  of  the  most  egregious  sort 
and  leads  to  equally  muddled  reasoning  on  the  question  of  causality  in 
order  to  avoid  a  repugnant  conclusion  as  to  the  justice  of  things  as  they 
are.  The  question  cannot  be  gone  into  here,  but  a  little  consideration 
will  show  that  there  is  almost  no  case  at  all  for  an  identification  or  close 
assimilation  of  causal  contribution  to  production  with  moral  desert  in 
distribution.  The  inequalities  in  inherited  property  and  opportunity  in 
several  senses  are  obvious,  but  it  must  also  be  recognized  that  natural 
differences  in  personal  capacity  are  equally  powerless  to  create  a  valid 
moral  claim  to  favored  treatment. 


116  RISK,  UNCERTAINTY,  AND  PROFIT 

prices  and  costs  of  consumption  goods,  we  can  bring  the 
two  analyses  together  and  see  the  relations  of  the  three 
sets  of  price  facts  —  values  of  goods,  costs  of  goods,  and 
values  of  productive  services.  It  is  obvious  that  as  aggre- 
gates the  three  concepts  are  identical,  all  being  in  fact  the 
social  income  looked  at  from  different  points  of  view. 

From  the  standpoint  of  the  present  problem  of  the 
"static  state"  the  supplies  of  all  productive  agencies  are 
rigidly  fixed,  and  the  theory  of  the  valuation  of  their  serv- 
ices is  closely  parallel  to  the  market  price  theory  as  given 
in  the  last  chapter  for  consumption  goods.  The  facts  of 
demand  and  supply  for  any  particular  kind  of  agency  can 
be  presented  in  the  form  of  schedules  or  graphs  showing 
the  respective  amounts  that  will  be  forthcoming  and  that 
can  be  sold  at  each  price,  and  the  equilibrium  point  would 
be  manifest  in  such  a  presentation.  The  facts  on  both  the 
supply  and  demand  sides  of  the  relation  are  more  com- 
plicated than  in  the  case  of  consumption  goods.  On  the 
supply  side  we  cannot  take  the  amount  in  existence  even 
at  a  moment  as  a  given  physical  datum.  For  we  are  deal- 
ing with  the  services  of  a  particular  kind  of  agency,  not  the 
agency  as  such.  The  amount  of  the  agency  is  fixed,  but 
the  amount  of  marketable  service  forthcoming  from  it  may 
well  vary  with  the  price  offered.  Two  courses  are  open. 
We  may  define  and  classify  services  on  the  basis  of  the 
physical  characteristics  of  the  agencies  which  render  them 
or  in  terms  of  the  physical  result  produced.1  Let  us  take 
first  agencies  as  physically  defined.  In  this  case  the  effect  of 
the  substitution  of  more  or  less  similar  agencies  is  to  be 
taken  into  account  in  plotting  the  demand  curve;  supply 
means  the  supply  of  the  services  of  a  particular  kind  of 
physical  agent,  things  which  are  perfectly  homogeneous  and 
universally  interchangeable  alone  being  grouped  together. 

1  It  seems  to  me  a  manifest  absurdity  to  define  them  in  price  terms  as 
does  Professor  J.  B.  Clark.  (The  Distribution  of  Wealth,  chap,  vi.)  There 
would  be  only  one  factor  if  measured  in  price  terms,  and  the  theory  of  dis- 
tribution would  be  a  pure  petitio  principii. 


JOINT  PRODUCTION  AND  CAPITALIZATION    117 

It  is  usual,  because  superficially  "natural'*  to  assume 
that  a  man  will  work  more  —  i.e.,  work  harder  or  more 
hours  per  day  —  for  a  higher  wage  than  for  a  lower  one. 
But  a  little  examination  will  show  that  this  assumption 
is  for  rational  behavior  incorrect.  In  so  far  as  men  act 
rationally  —  i.e.,  from  fixed  motives  subject  to  the  law  of 
diminishing  utility  —  they  will  at  a  higher  rate  divide 
their  time  between  wage-earning  and  non-industrial  uses  <v,_ 
in  such  a  way  as  to  earn  more  money,  indeed,  but  to  work 
fewer  hours.  Just  where  the  balance  will  be  struck  depends 
upon  the  shape  of  the  curve  of  comparison  between  money 
(representing  the  group  of  things  purchasable  with  money)  v 
and  leisure  (representing  all  non-pecuniary,  alternative 
uses  of  time).  We  therefore  draw  our  momentary  supply 
line  in  terms  of  price  with  some  downward  slope.1 

1  If  this  conclusion  is  not  evident  after  a  little  reflection  it  may  be 
demonstrated  by  reasoning  as  follows.  Suppose  that  at  a  higher  rate  per 
hour  or  per  piece,  a  man  previously  at  the  perfect  equilibrium  adjust- 
ment works  as  before  and  earns  a  proportionally  larger  income.  When, 
now,  he  goes  to  spend  the  extra  money,  he  will  naturally  want  to  in- 
crease his  expenditures  for  many  commodities  consumed  and  to  take  on 
some  new  ones.  To  divide  his  resources  in  such  a  way  as  to  preserve  equal  •■  *  > 
importance  of  equal  expenditures  in  .all  fields  he  must  evidently  lay  out 
part  of  his  new  funds  for  increased  leisure;  i.e.,  buy  back  some  of  his 
working  time  or  spend  some  of  his  money  by  the  process  of  not  earning  it. 
The  conclusion  is  enforced  by  the  important  practical  consideration  that 
the  expenditure  of  money  also  requires  time  and  energy  which  must  be 
saved  from  the  work  period  if  the  best  results  are  to  be  secured. 

The  facts  as  to  the  shape  of  the  supply  curve  of  labor  from  given  labor- 
ers are  well  known  to  employers  of  native  workmen  in  backward  coun- 
tries, especially  the  tropics.  White  men  in  the  advanced  industrial  nations 
have  not  always  behaved  so  rationally;  their  traditions  give  them  a 
higher  preference  for  the  kinds  of  satisfactions  purchasable  with  money 
in  comparison  with  the  more  inward  and  spiritual  enjoyments.  But  the 
effect  which  was  to  be  anticipated  was  very  conspicuous  after  the  out- 
break of  the  World  War,  when  the  wages  for  certain  kinds  of  work  rose  CKjl« 
to  unprecedented  heights  and  produced  increased  loafing  and  dissipation 
instead  of  increased  production.  (It  is  important  to  bear  in  mind  that  we 
are  speaking  of  a  permanent  change;  it  would  be  in  keeping  with  rationality 
to  work  harder  at  a  temporarily  higher  rate  in  order  to  purchase  more 
leisure  later  on.) 

While  on  the  subject  we  may  observe  that  it  is  also  an  error  to  assume 


118 


RISK,  UNCERTAINTY,  AND  PROFIT 


The  second  alternative  is  to  define  agencies  or  factors 
in  terms  of  the  physical  results  which  they  produce.  When 
this  is  done  the  shape  of  the  supply  curve  at  a  moment  will 
depend  simply  on  the  degree  of  specialization  of  the  service 
under  discussion.  At  one  extreme  we  would  have  an  un- 
specialized  service,  such  as  unskilled  labor  in  a  certain 
employment.  For  such  a  service  there  would  be  no  supply 
at  all  below  the  established  competitive  price  in  all  uses, 
and  a  virtually  unlimited  supply  above  that  price.  That  is, 
the  supply  curve  as  a  function  of  price  would  be  a  vertical 
line.  At  the  other  extreme  would  be  absolutely  specialized 
services,  such  as  diamond  cutters  or  aviators.  For  these 
there  would  be  no  supply  below  a  certain  minimum  price, 
what  such  men  can  earn  in  other  lines  of  work,  and  as  the 
price  rose  the  supply  would  rapidly  increase  until  the  men 
trained  for  the  service  were  all  employed  in  it,  beyond 
which  the  curve  would  merge  into  the  supply  curve  pre- 
viously discussed  of  services  from  given  agencies.  (See 
accompanying  graphs,  which  show  supply  as  a  function 
of  price.) 


Services  from  given 
agencies 


An  unspecialized 
service 


A  specialized  service 


In  regard  to  demand,  also,  the  case  of  productive  serv- 
ices is  less  simple  than  that  of  consumptive  goods;  de- 
mand is  (a)  always  indirect  or  derived,  a  reflection  of  the 

that  in  this  respect  land  or  other  property  services  will  be  different  from 
labor.  These  agencies  also  have  alternative  non-pecuniary  uses,  and  if, 
say,  the  rent  on  land  were  to  rise,  landowners  could  afford  to  use  more 
of  it  for  lawns,  flower  gardens,  athletic  grounds,  game  preserves,  pleasure 
parks,  etc.,  and  less  for  cultivation  and  marketable  crops;  and  if  they 
calculated  closely  they  would  do  so. 


JOINT  PRODUCTION  AND  CAPITALIZATION    119 

demand  for  the  products  of  the  agency,  and  (b)  always 
joint  in  character.  In  connection  with  the  first  fact,  the 
demand  is  also  highly  composite;  identical  productive 
agencies  minister  alternately  to  a  vast  range  of  wants  and 
widely  different  agencies  to  the  same  wants.  These  com- 
plexities in  the  use  of  productive  services  make  a  really 
logical  classification  of  them  a  difficult  if  not  impossible 
problem.  The  fact  of  joint  demand,  as  we  have  seen, 
differentiates  producer's  goods  from  consumer's  goods  in 
degree  only,  and  to  a  relatively  limited  degree. 

The  shape  of  the  demand  curve  showing  possible  sales  of 
the  services  of  any  physically  defined  type  of  agency  as  a 
function  of  price  is  similar  to  that  of  the  consumption  goods 
demand  curve.  It  is  the  curve  of  diminishing  value  pro- 
ductivity already  described,  descending  in  consequence 
both  of  decreasing  physical  productivity  and  decreasing 
price.  That  is,  if  the  supply  of  any  productive  agency  be 
increased  the  proportion  of  that  agency  in  combinations  in 
which  it  is  employed  will  be  raised  all  along  the  line,  and  at 
the  same  time  there  will  be  a  relative  increase  in  the  pro- 
duction of  those  commodities  in  which  its  use  is  relatively 
important  with  a  consequent  decline  in  their  relative  price. 
^The  equilibrium  price  point  under  static  conditions  is 
practically  the  specific  productivity  of  the  given  supply  of 
the  agency  (though  we  must  remember  that  there  is  some 
variation  in  supply  of  service  as  price  varies  even  at  a  mo- 
ment). In  the  equilibrium  condition,  that  is  to  say,  the' 
value  of  each  service  is  equal  to  the  value  of  its  contribu- 
tion to  the  total  product,  and  the  contributions  of  physi- 
cally similar  agencies  are  of  equal  value  throughout  the 
systemP  It  is  evident  that  this  adjustment  fixes  the  prices 
of  consumption  goods  at  the  same  time  with  those  of  pro- 
ductive services,  and  we  may  apply  the  supply  and  de- 
mand analysis  to  consumption  goods  also,  giving  the 
theory  of  normal  price  in  contrast  with  the  theory  of 
market  price  studied  in  the  last  chapter. 


120  RISK,  UNCERTAINTY,  AND  PROFIT 

At  a  moment,  the  theoretical  price  of  any  good  is  the 
("marginal")  demand  price  of  the  existing  supply,  the 
highest  uniform  price  that  will  take  the  supply  out  of  the 
market.  The  supply  is  a  given  physical  fact,  not  an  eco- 
nomic variable,  but  a  constant  in  the  equation.  The 
equilibrium  price  of  a  good  over  a  long  period  is  a  different 
problem.  Here  it  is  not  the  amount  of  the  good  that  is 
constant  (together  with  the  facts  of  demand),  but  (under 
"static"  conditions)  the  conditions  of  production  of  goods 
in  general  (and  of  demand).  The  supply  of  any  particular 
good  may  change  freely  and  will  do  so  as  its  price  varies, 
other  things  being  equal.  The  price  must  be  adjusted  not 
to  dispose  of  a  fixed  supply,  but  to  equate  a  rate  1  of  pro- 

y  duction  with  a  rate  of  consumption,  both  variable  with  or 
"functions  of"  the  price. 

No  particular  reinterpretation  of  the  demand  curve  is 
called  for,  however,  the  only  new  problem  being  on  the 
supply  side.  cAssuming  for  the  moment  that  the  rate  of 
supply  as  well  as  the  rate  of  demand  is  in  fact  a  function  of 
price,  it  is  evident  that  the  price  must  move  toward  an 
equilibrium  point  equating  the  two  rates;  for  goods  can- 

*/'  not  be  consumed  more  rapidly  than  they  are  produced 
and  will  not  be  produced  more  rapidly  than  they  are  con- 
sumed. Any  difference  either  way  will  at  once  react  on 
the  price  and  the  price  will  react  on  the  production  and 
consumption  rates  in  accordance  with  the  assumed  func- 
tional relations,  and  so  on  until  the  demand  and  supply 
both  correspond  to  the  existing  priced 
c  To  investigate  the  basis  and  character  of  the  relation 
between  supply  and  price,  we  must  consider  the  motives 

yr  which  control  production.  The  productive  group  or  es- 
tablishment, however  organized,  must  pay  its  members 
(the  owners  of  productive  services)  enough  to  retain  them; 

1  Marshall  correctly  treats  long-time  demand  and  supply  as  time  rates, 
but  does  not  sharply  contrast  this  form  of  the  variable  with  the  absolute 
amounts  dealt  with  in  market  price. 


JOINT  PRODUCTION  AND  CAPITALIZATION    121 

i.e.,  it  must  meet  competition.  When  any  group  can  hire  a 
new  member  at  a  profit  it  will  do  so,  and  clearly  it  can  get 
any  new  member  by  raising  ever  so  little  the  remuneration 
he  is  receiving  elsewhere.  Clearly,  also,  it  will  dispense  with 
any  member  who  must  be  employed  at  a  loss;  i.e.,  any  to 
whom  competing  groups  can  afford  to  pay  more  than  it 
can  afford  to  pay.  The  amount  of  any  commodity  that 
will  be  produced  at  any  price,  therefore,  tends  quickly 
toward  the  amount  that  will  yield  neither  profit  nor  loss, 
for  when  production  yields  ever  so  little  profit  it  will  in- 
crease, and  vice  versa  J  For  the  study  of  this  adjustment  it 
is  convenient  to  interchange  the  axes  of  our  previous  graph 
and  view  cost  and  selling  price  as  functions  of  the  size  of 
supply. 

It  is  usually  assumed  that  cost  may  either  increase,  re- 
main constant  or  decrease  as  supply  is  increased.1  (Sell- 
ing price,  of  course,  practically  always  decreases.)  The 
question  is  really  one  of  the  most  difficult  and  perhaps 
one  of  the  worst  muddled  in  economic  theory  and  cannot 
be  adequately  treated  here.  But  examination  seems  to  show 
that  under  the  conditions  necessary  to  perfect  competition, 
costs  must  always  increase  as  supply  increases.  If  there 
is  to  be  competition,  conditions  must  be  such  that  an 
establishment  of  relatively  small  size  in  comparison  with 
the  industry  as  a  whole  is  more  efficient  than  a  large  one; 
otherwise  monopoly  will  result.  New  supply  will  then 
come  through  an  increase  in  the  number  of  similar  es- 
tablishments, not  through  an  increase  in  the  size  of  any 
of  them,  and  no  economies  of  large-scale  production  will 
be  realized. 

On  the  contrary,  the  increased  supply  must  mean  a  di- 
version of  productive  resources  from  other  uses,  which  will 
raise  their  price  in  those  uses  through  the  decreased  out- 
put and  consequent  rise  in  price  of  the  competing  product. 
Of  course,  if  competition  exists  the  price  will  go  up  uni- 
x  Cf.  Taussig,  Principles  of  Economics,  chaps.  12, 13, 14. 


122  RISK,  UNCERTAINTY,  AND  PROFIT 

formly  to  all  producers,  and  it  goes  without  saying  that  the 
cost  of  all  units  of  the  supply  is  the  same.1 

The  precise  form  of  the  cost  function  will  depend  on  the 
importance  of  the  particular  good  in  the  demand  for  the 
productive  services  which  enter  into  it.  If  its  production 
constitutes  a  negligible  fraction  of  the  demand  for  all  these 
services,  we  shall  have  practically  constant  cost;  if  a  con- 
siderable fraction,  a  more  rapidly  rising  cost.  It  will  also 
vary  with  the  character  of  the  function  representing  the 
law  of  decreasing  returns  in  the  given  technological  sit- 
uation; for  as  production  is  increased  the  proportions  of 
more  abundant  agencies  will  be  increased  relatively  to 
those  more  limited  in  supply.  The  graph  on  p.  91  shows 
the  character  of  the  functions  and  the  meaning  of  equi- 
librium, and  is  applicable  also  to  conditions  of  joint  pro- 
duction. 

c  The  equilibrium  condition  or  long-run  tendency  for  the 
static  state  has  now  been  formulated  in  three  ways  from  as 
many  different  standpoints.  From  the  standpoint  of  dis- 
tribution, every  agency  must  be  in  the  situation  where  it 
can  make  the  greatest  possible  value  contribution  to  the 
social  income  and  be  valued  by  the  contribution  which  it 
makes.  From  the  standpoint  of  consumption  goods,  prices 
must  be  such  that  rates  of  production  and  consumption  are 
equal  or  that  costs  and  selling  prices  per  unit  are  every- 
where the  same.^It  is  important  to  see  clearly  that  these 
statements  are  logically  equivalent,  presenting  different 
aspects  of  the  same  phenomena.  It  is  self-evident  that 
costs  of  goods  are  identical  in  the  aggregate  with  distrib- 
utive shares,  and  both  with  prices  of  goods;  all  three  are 
in  fact  different  names  for  the  total  income  of  the  society. 

1  Economic  literature  is  full  of  the  contrary  assumption,  but  it  is  a 
definite  error,  in  dealing  with  long-time  normal  price.  The  existence  of 
differences  in  costs  in  different  establishments  in  an  industry  is  proof, 
when  not  due  to  differences  in  accounting  practice,  that  the  competitive 
adjustment  is  imperfect.  The  current  conception  of  marginal  cost 
necessarily  falls  away  through  the  same  reasoning.  The  producer's  cal- 
culations are  made  in  terms  of  cost  per  unit  and  selling  price  per  unit. 


JOINT  PRODUCTION  AND  CAPITALIZATION    123 

tA  formulation  including  all  these  statements  would  be  that 
consumption  goods  and  productive  services  must  be  so 
priced  that  equal  price  amounts  of  the  second  make  equal 
price  contributions  of  the  first  which  have  equal  utilities  to 
all  persons  in  the  system.  It  is  really  self-evident  that  this 
condition  alone  can  be  stable,  that  any  other  sets  forces  to 
work  to  bring  it  about-3 

Hitherto  we  have  dealt  only  with  different  sorts  of  hu- 
man services  as  giving  rise  to  the  phenomena  of  competitive 
imputation.  The  meaning  and  role  of  property  in  the 
problem  of  economic  organization  next  call  for  notice. 
We  have  seen  that  material  productive  goods  do  not 
modify  the  principles  of  organization  so  long  as  they  are 
not  subject  to  increase  or  decrease  and  not  separable  from 
the  persons  of  their  owners,  to  whose  personal  capacities 
the  same  restrictions  must  apply. 

The  conventional  classification  of  productive  agencies 
under  the  three  categories  of  land,  labor,  and  capital  has 
several  times  in  the  foregoing  pages  been  referred  to  ad- 
versely, and  it  is  appropriate  at  this  point  to  take  up  for 
somewhat  more  detailed  notice  the  difficult  problem  of 
correct  definition  and  classification.  It  is  evident  that  all 
these  classes  are  anything  but  homogeneous,  that  different 
human  beings,  different  machines,  and  different  natural 
agents  show  the  greatest  diversity  in  characteristics  and  in 
the  services  which  they  perform.  Cairnes's  attempt  to 
reduce  labor  to  more  approximately  homogeneous  bodies 
gave  us  the  famous  "non-competing  groups."  Still  more 
obtrusive  are  the  dissimilarities  of  different  natural  agents 
—  wheat  land  vs.  pineapple  land,  arable  vs.  grazing  or 
timber,  and  all  contrasted  with  mineral-bearing  and  the 
multitudinous  kinds  of  the  latter.  Capital  is  somewhat 
peculiar  in  this  respect,  its  "fluidity"  depending  on  the 
length  of  time  taken  into  view. 

On  the  other  hand,  it  is  if  possible  a  more  important  fact 
that  agencies  from  different  classes  and  of  the  most  diver- 


124  RISK,  UNCERTAINTY,  AND  PROFIT 

gent  physical  properties  may  be  equivalent  and  inter- 
changeable with  respect  to  the  results  which  they  achieve. 
As  Carver  has  observed,  a  (human)  ditch-digger  is  eco- 
nomically as  closely  akin  to  a  steam  shovel  as  he  is  to 
a  bookkeeper.1  Indeed,  the  possibility  of  a  competitive 
organization  of  society  depends  on  the  fact  of  varying 
proportions,  that  no  particular  agency  is  indispensable, 
but  that  within  limits  they  may  be  substituted  for  each 
other  and  therefore  each  must  compete  with  others  of 
different  kinds  for  its  place.  It  is  evident  that  otherwise 
producers  would  not  be  in  the  market  for  the  agencies 
separately  and  they  could  not  be  separately  evaluated 
through  competitive  bidding.  The  existence  of  a  problem 
of  distribution  depends  on  the  cooperation  of  different 
kinds  of  agencies  performing  physically  different  operations 
in  the  creation  of  product,  and  the  possibility  of  solving 
the  problem  depends  on  the  equivalence  of  determinate 
amounts  of  the  several  services  in  contributing  to  the  value 
result.  It  follows  at  once  that,  as  already  observed,  no 
classification  or  measurement  of  productive  services  on  the 
basis  of  their  contributions  has  any  meaning  for  the  dis- 
tribution problem.  According  to  such  a  standard  they  all 
form  one  vast  homogeneous  fund.2 

1  The  Distribution  of  Wealth,  p.  85;  cf.  also  Davenport,  Economics  of 
Enterprise,  chaps,  xi  and  xxii. 

2  Reference  has  been  made  to  the  absurdity  of  the  two-factor  analysis, 
as  exemplified  particularly  in  the  work  of  Professor  J.  B.  Clark.  The  same 
author  falls  into  the  closely  related  fallacy  of  measuring  separate  agencies 
by  their  productive  contributions.  He  recognizes  and  clearly  states  the 
difficulty  {The  Distribution  of  Wealth,  p.  374,  note)  and  ostensibly  gets 
around  it  by  setting  up  an  absolute  subjective  standard  of  measurement. 
It  is  very  difficult  for  the  present  writer  to  criticize  this  reasoning,  and 
out  of  the  question  in  the  space  available;  I  can  see  nothing  in  it  but  a 
complete  failure  to  make  connections,  a  palpable  non  sequitur.  It  is  to  be 
observed  that  the  fallacy  is  equally  involved  in  all  other  distribution 
theory  which  makes  use  of  "  factors  "  at  all  —  the  number  is  immaterial  — 
and  this  includes  most  of  the  literature  of  the  subject. 

A  conspicuous  exception  is  Davenport's  discussion  (Economics  of 
Enterprise,  chaps,  xi  and  xxii)  already  mentioned,  which  is  excellent  for 
this  phase  of  the  question.  Where  it  falls  short  is  in  failing  adequately  to 


JOINT  PRODUCTION  AND  CAPITALIZATION    125 

The  problem  is  really  a  difficult  one,  and  cannot  be 
passed  over,  since  we  cannot  discuss  the  valuation  of 
things  without  knowing  what  it  is  that  is  being  evaluated. 
Much  the  same  difficulty,  however,  was  met  with,  as  will 
be  recalled,  in  the  sphere  of  consumption  goods,  and  the 
answer  must  come  from  the  same  source  in  the  two  cases  — 
an  appeal  to  the  unsophisticated  facts  of  the  market. 
Things  quoted  under  the  same  name  and  identically  priced 
may  be  taken  as  identical,  and  vice  versa.  Some  special 
features  of  the  present  case  may  be  mentioned,  however. 
In  the  first  place,  interchangeability  of  productive  agents 
depends  on  the  use;  two  things  may  be  equivalent  for  one 
purpose,  entirely  dissimilar  for  another.  This  is  not  nearly 
so  true  of  consumption  goods,  which,  indeed,  are  not 
generally  open  to  such  a  complex  variety  of  uses.  Inter- 
changeability is  also  a  matter  of  time.  The  problem  of 
changing  the  form  of  productive  agencies  and  adapting 
them  to  new  uses  carries  us  into  long-time  considerations, 

separate  the  long  and  short  period  problems  of  distribution.  It  is  this 
failure  which  in  the  writer's  view  explains  most  of  the  controversial 
differences  between  economists  in  so  far  as  they  relate  to  the  scientific  ex- 
planation of  distribution,  and  not  to  questions  of  propriety  or  policy.  It 
is  essential  to  take  account  of  the  fact  that  from  the  long-time  point  of 
view  the  question  of  classification  takes  on  a  different  aspect,  becoming  a 
question  of  the  conditions  of  supply  of  different  types  of  agents.  The 
case  for  the  conventional  tripartite  division  (or  more  especially  the  separa- 
tion of  land  and  capital)  is  argued  at  length  in  A.  S.  Johnson's  Rent  in 
Modern  Economic  Theory.  (See  especially  pp.  35  ff.)  This  phase  of  the 
problem  will  presently  come  up  for  discussion,  and  it  will  be  pointed  out 
that  there  is  danger  of  over-simplification  here  also.  (See  below,  chap- 
ter v. 

It  may  strike  the  attention  of  the  reader  that  while  the  tripartite 
classification  is  emphatically  repudiated,  the  factors  are  still  commonly 
referred  to  in  the  present  essay  as  "land,  labor,  and  capital."  If  ex- 
planation is  called  for,  it  is  to  be  found  in  the  necessity,  for  mere  exposi- 
tory purposes,  of  some  expression  which  explicitly  covers  the  whole 
group.  The  significance  is  the  opposite  of  classificatory;  "animal, 
vegetable,  and  mineral,"  or  "solid,  liquid,  and  gaseous  agencies"  could 
have  been  used  but  for  their  unfamiliarity  in  this  connection.  Also  the 
familiar  terms  have  social  and  ethical  significance  if  none  of  a  strictly 
economic  sort. 


126  RISK,  UNCERTAINTY,  AND  PROFIT 

and  especially  the  meaning  of  capital,  which  will  come  up 
in  the  next  chapter.  It  will  be  seen  that  examination  tends 
to  widen  the  capital  category  greatly;  most  productive  serv- 
ices ultimately  represent  a  previous  investment  of  resources 
of  some  sort. 

The  variation  in  interchangeability  in  different  uses  in- 
troduces a  special  complication  which  has  caused  confusion. 
The  consideration  which  finally  determines  is  not  inter- 
changeability in  creating  any  particular  physical  product, 
but  a  certain  amount  of  value.  The  former  variety  of  inter- 
changeability is  not  in  fact  a  necessary  condition  for  the 
operation  of  competitive  distribution.  If  agencies  are  com- 
bined in  different  uses,  effective  substitution  is  secured 
through  relative  growth  or  decay  of  the  different  industries. 
We  have  previously  remarked  that  Wieser,  who  repudiates 
the  productivity  theory  of  distribution  as  based  on  varia- 
tion in  proportions,  puts  forth  the  really  equivalent  theory, 
based  on  different  proportions  in  different  combinations. 
Taylor,  however,  takes  the  latter  method  for  his  explanation 
of  the  productivity  theory,  but  points  out  that  the  two  are 
equivalent.  Both  sorts  of  variations  in  proportion  are,  of 
course,  concerned  in  the  actual  working  of  the  market  for 
productive  services,  and  systematically  occur  together,  as 
explained  in  our  exposition  of  distribution  theory  just 
given.1 

To  conclude  this  brief  discussion  of  the  productive  serv- 
ices, we  may  merely  notice  the  invalidity  of  four  com- 
monly assumed  grounds  of  distinction  between  labor  and 
property  services:  (1)  Activity  vs.  passivity.  It  is  char- 
acteristic of  the  enterprise  organization  that  labor  is  di- 
rected by  its  employer,  not  its  owner,  in  a  way  analogous  to 
material  equipment.  Certainly  there  is  in  this  respect  no 
sharp  difference  between  a  free  laborer  and  a  horse,  not  to 
mention  a  slave,  who  would,  of  course,  be  property.  Closely 
related  is  (2)  the  question  of  preference  in  the  agency  itself 
1  See  above,  p.  119. 


JOINT  PRODUCTION  AND  CAPITALIZATION    127 

as  to  (a)  the  kind  and  (b)  the  amount  of  service  to  be  per- 
formed. But  here  also  there  is  at  most  a  vague  difference  in 
degree;  the  owner  of  property  quite  commonly  does  have 
moral  or  sentimental  reasons  for  restricting  the  field  of  its 
employment.  We  must  not  confuse  the  agency  actually 
performing  work  with  the  personality  of  its  owner,  and  it 
appears  that  a  tool  or  a  building  or  a  piece  of  land  is  in  this 
regard  similar  to  a  man's  hand  or  brain.  Similarly  as  to  (b) 
the  amount  of  work  done.  It  may  be  urged  that  material 
agents  do  not  care  whether  they  work  or  not.  But  the 
ground  for  restricting  hours  of  labor  or  taking  a  vacation 
is  a  possible  alternative  use  for  one's  personal  resources 
or  the  desire  to  conserve  them  unimpaired,  and  the  same 
considerations  apply  to  property  resources.1 

(3)  Another  superficial  difference  which  similarly  dis- 
solves under  scrutiny  relates  to  "sub-marginal"  agencies 
—  too  poor  in  quality  to  be  employed.  It  may  be  urged 
that  there  is  no  wageless  labor  analogous  to  free  land.  As 
a  matter  of  fact,  however,  marginal  and  sub-marginal  hu- 

1  The  notion  of  sacrifice  has  been  overworked  in  economics.  Econo- 
mists as  well  as  employers  have  been  too  prone  to  assume  that  sub- 
jective willingness  is  the  principal  limitation  on  the  amount  of  labor  ob- 
tained from  given  persons  or  for  a  given  outlay.  And  employers  as  well 
as  economists  are  waking  up  to  the  efficiency  of  well-paid  labor.  There  is 
no  doubt  that  employers  as  a  class  have  lost  much  money  (not  to  mention 
the  higher  considerations  involved)  through  working  their  employees 
beyond,  and  feeding,  clothing,  and  amusing  them  below,  the  point  of 
maximum  physical  efficiency.  This  would  not  be  done  with  a  dumb 
animal!  Of  course  it  may  be  profitable  to  the  individual  employer  to  pay 
a  wage  below  what  is  necessary  to  maintain  maximum  efficiency  and  an 
adequate  supply  of  labor  from  generation  to  generation  (if  the  working 
class  maintains  the  labor  supply  partly  at  its  own  cost) ;  what  is  meant  is 
that  they  have  paid  uneconomically  low  wages  even  from  the  standpoint 
of  the  short  periods  for  which  they  have  to  deal  with  the  same  individual 
laborer.  The  presence  of  idle  equipment  is  a  great  temptation  to  an  em- 
ployer, and  the  debit  side  of  overworked  help  is  less  conspicuous  to  view. 
Of  course  the  ignorance  and  imprudence  of  the  workers  are  as  much 
in  point  as  those  of  the  employer.  It  is  of  interest  that  Lord  Leverhulme 
has  recently  put  forth  the  contention  that  a  six-hour  day,  without  de- 
creased pay,  would  be  profitable  to  British  employers  in  many  industries, 
if  the  men  would  consent  to  two  shifts  during  each  twenty-four  hours. 


128  RISK,  UNCERTAINTY,  AND  PROFIT 

man  beings  are  nearly  as  common  and  significant  a  phenom- 
enon as  in  the  case  of  land,  and  far  surpass  capital  in  this 
respect.  Every  man  is  a  sub-marginal  laborer  for  a  con- 
siderable fraction  of  his  life  at  each  end  of  it,  and  institutions 
are  full  of  sub-marginal  men.  And  there  are  thousands  and 
millions  of  other  idle  man-hours  in  a  year  which  would  be 
devoted  to  anything  that  brought  in  the  least  return  above 
the  competitive  pay  which  would  have  to  be  given  to  the 
equipment  necessary  to  employ  them.  On  the  other  hand, 
the  same  fallacious  reasoning  noted  in  connection  with 
overwork  undoubtedly  leads  to  the  employment  of  large 
numbers  who  use  equipment  which  would  yield  more  pro- 
duct if  employed  in  the  "more  intensive  exploitation"  of 
more  competent  workers.1 

(4)  The  most  important  alleged  difference  between 
property  and.  personal  powers,  the  moral  aspect,  is  not 
strictly  within  the  scope  of  a  purely  descriptive  discussion 
such  as  the  present,  but  it  may  be  in  place  to  observe  that 
it  also  is  largely  unreal.  The  contrast  between  personal- 
service  income  as  " earned "  and  property  income  as  "un- 
earned," of  which  much  is  made  by  "reformers,"  is  dis- 
tinctly misleading;  it  is  difficult  if  not  impossible  to  find 
grounds  for  a  moral  distinction  of  any  general  validity  be- 
tween the  two.  "Some  are  born  great,  some  achieve  great- 
ness, and  some  have  greatness  thrust  upon  them";  and  the 
same  applies  quite  as  well  to  wealth.  And  the  task  of 
separating  the  portion  of  product  or  capacity  to  produce 
which  is  due  to  conscientious  effort  from  that  which  goes 

1  This  is  being  recognized  in  the  case  of  child  labor  by  many  employers 
who  refuse  to  employ  children  simply  on  the  ground  that  it  does  not  pay 
in  the  business  sense.  This  whole  problem  becomes  more  important  as 
the  amount  of  capital  per  worker  increases.  It  is  also  true  that  the  in- 
creasing use  of  machinery  provides  tasks  which  a  lower  and  lower  grade  of 
human  capacities  are  required  to  perform.  The  net  result  is  difficult  to 
estimate.  The  social  problem  of  the  "unemployable"  —  how  to  identify 
him  and  what  to  do  with  him  —  is  surely  forbidding  enough.  Like  most 
of  our  new  troubles,  it  is  partly  a  product  of  the  disintegration  of  the 
family  as  well  as  of  industrial  changes  directly. 


JOINT  PRODUCTION  AND  CAPITALIZATION    129 

back  to  inherited  advantage  or  pure  luck  is  about  as  im- 
possible —  and  the  evil  results  of  making  a  false  separation 
perhaps  about  as  great  —  in  one  case  as  in  the  other.  There 
is  a  difference  of  some  significance  in  the  practical  possi- 
bility of  effecting  a  redistribution  in  the  two  cases,  which 
brings  us  back  to  the  one  specification  which  we  found  it 
necessary  to  lay  down  in  regard  to  property  in  order  to 
exclude  it  as  a  complicating  fact;  it  is  separable  from  the 
person  of  its  owner,  and  labor  generally  is  not,  or  is  so  to 
nothing  like  the  same  degree.  The  only  conclusion  as  to 
social  policy  which  we  shall  insert  here  is  the  insistence 
that  "society"  must  get  rid  of  the  idea  that  because  in- 
come is  "earned"  it  is  "deserved "and  not  otherwise.  We 
are  already  far  from  this  view  in  practice,  as  is  shown  by 
the  indiscriminate  taxation  of  large  "service"  incomes  and 
assistance  of  the  unfortunate  and  incapable.  If  we  are 
to  have  organized  society  and  maintain  human  standards 
of  life,  we  must  either  radically  eliminate  weakness  or  im- 
pose upon  strength  the  burdens  which  weakness  cannot 
bear.  (And  even  then  there  are  limits  to  the  possible  tol- 
eration of  weakness,  and  the  luck  element  would  still  re- 
main!) 

Turning  again  now  to  consider  the  causal  relations  to 
economic  organization  of  the  one  causally  significant  dis- 
tinguishing attribute  of  property,  let  us  first  suppose  that  in 
our  society  some  property  is  separable  by  lease,  though  not 
by  sale,  from  the  person  of  its  owner.  The  only  difference 
will  be  that  the  owner  of  such  property  may  belong  to  more 
than  one  productive  group  and  contribute  more  than  one 
kind  of  service  at  the  same  time.  The  principles  of  or- 
ganization of  the  system  as  a  whole  are  in  no  wise  affected 
by  this  change  in  the  conditions  of  competitive  arrange- 
ments. 

The  possibility  of  the  permanent  transfer  of  property  by 
exchange,  even  though  not  subject  to  increase  or  decrease, 
does  introduce  some  new  factors  into  our  problem.  These 


130  RISK,  UNCERTAINTY,  AND  PROFIT 

results  are  closely  related  to  the  bearings  of  another  ab- 
straction hitherto  made,  the  continuity  and  timelessness  of 
the  production-consumption  process.  Consequently,  we 
must  first  get  rid  of  this  simplification  and  consider  the 
effect  of  the  abstracted  element.  What  then  will  hap- 
pen in  a  society  such  as  we  have  studied  when  conditions 
are  so  modified  in  the  direction  of  reality  that,  while  per- 
fect knowledge  and  static  conditions  in  other  respects  are 
maintained,  the  production  process  is  protracted  over  a 
considerable  period  of  time  and  split  up  into  complicated 
stages  and  subdivisions,  and  when,  moreover,  goods  need 
no  longer  be  consumed  at  once  when  finished,  but  may  be 
stored  for  future  use,  or  exchanged? 

The  division  of  the  productive  process  into  stages  car- 
ried on  in  different  groups  or  plants  is  a  detail  connected 
with  the  time  length  of  the  process,  but  which  we  can  pass 
over  with  brief  notice.  It  is  in  fact  a  relatively  accidental 
matter  of  organization,  and  under  the  "frictionless"  con- 
ditions here  assumed  it  would  make  no  practical  difference 
whether  successive  processes  in  the  making  of  an  article 
were  integrated  through  the  internal  organization  of  a  sin- 
gle group  or  through  the  external  mechanism  of  market 
dealings  between  groups.  Under  these  conditions  there 
will  be  in  existence  at  any  time  a  complex  aggregate  of 
partial  products,  goods  in  process,  which  of  course  will 
have  value.  We  must  separate  that  element  in  the  value 
of  the  partial  products  which  is  due  merely  to  the  stored- 
up  productive  energy  which  they  contain  from  any  modi- 
fication of  this  value  due  to  the  direct  psychical  influence  of 
the  time  which  must  elapse  before  they  are  ready  for  con- 
sumption. 

The  relation  of  time  to  the  production  and  consump- 
tion of  goods  is  a  complicated  and  controversial  question; 
while  only  a  very  brief  discussion  can  be  attempted  here, 
it  is  necessary  to  make  a  superficial  survey.  The  assump- 
tion of  a  general  preference  in  human  nature  for  present 


JOINT  PRODUCTION  AND  CAPITALIZATION    131 

over  future  goods  is  so  commonly  and  confidently  made 
that  some  courage  is  required  to  call  in  question  the  founda- 
tions of  the  entire  body  of  doctrine  on  the  subject;  yet  it 
must  be  done.  Most  discussion  of  the  subject  is,  in  the 
writer's  view,  vitiated  by  a  false  conception  of  the  nature  of 
the  problem.  The  fact  of  the  existence  of  interest  in  society 
is  wrongly  taken  as  proving  that  men  discount  the  future. 
The  relation  between  interest  and  time  preference  is,  in 
fact,  inverted  in  this  view.  In  a  free  market  where  interest 
can  be  obtained  it  is  natural  that  men  should  esteem  a 
present  dollar  equally  with  its  amount  at  the  current 
interest  rate  at  a  future  date,  since  one  can  be  freely  ex- 
changed for  the  other.  Nor  does  the  fact  that  men  do  not 
postpone  all  consumption  of  goods  indefinitely  into  the 
future  argue  an  ingrained  abstract  preference  of  present 
to  future  consumption.  Neither  do  they  wish  to  compress 
all  the  satisfactions  of  a  lifetime  into  the  present  moment 
and  fast  forever  after,1  which  act  by  the  same  reasoning 
would  prove  a  disposition  to  discount  the  present  in  favor 
of  the  future. 

The  error  in  the  current  reasoning  is  a  wrong  choice  of  a 
zero  point  from  which  to  measure  time  preference.  The 
correct  basis  is  not  everything  to-day  and  nothing  in  the 
future;  a  more  sensible  form  of  question  would  be  this: 
If  one  had  to  choose  between  enjoyment  to-day  with  ab- 
stinence to-morrow  on  the  one  hand,  and  abstinence  to-day 
with  enjoyment  to-morrow,  on  the  other,  which  would  be 
more  desirable,  all  other  things  being  equal?  Or  better 
still,  if  a  man  were  given  his  entire  income  for  a  year  in  a 
lump-sum  payment  on  January  first,  how  would  he  dis- 
tribute its  expenditure  through  the  year?  There  would 
clearly  be  no  question  either  of  eating  it  all  up  the  first  day 

1  The  point  may  be  illustrated  by  the  anecdote  of  a  tramp  who,  finding 
a  hundred-dollar  bill,  made  a  bee-line  to  the  nearest  quick  lunch  and  ex- 
citedly ordered  a  hundred  dollars'  worth  of  ham  and  eggs.  That  men  do 
not  behave  after  this  fashion  does  not  prove  that,  other  things  equal, 
they  prefer  a  future  satisfaction  to  a  present  one  of  the  same  magnitude. 


132  RISK,  UNCERTAINTY,  AND  PROFIT 

or  saving  it  all  till  the  last  day;  a  zero  time  preference  ob- 
viously means  a  uniform  distribution  in  time.  Any  piling- 
up  of  consumption  at  an  earlier  date  to  be  compensated 
by  reduced  consumption  later  on  would  be  a  real  discount 
of  the  future,  while  to  skimp  now  for  the  sake  of  plenty  or 
luxury  in  the  future  would  be  to  discount  the  present.  Of 
course,  we  abstract  from  the  element  of  uncertainty  as  to 
the  future.  We  seem  justified  in  pronouncing  either  tend- 
ency irrational  if  other  things  are  really  reduced  to  equality 
in  the  alternatives.1 

As  to  the  facts  of  human  nature  it  is  safe  to  assume  that 
different  individuals  would  give  the  most  varied  forms  of 
distribution.  Doubtless  few,  if  any,  of  these  would  con- 
form to  straight  lines  or  smooth  curves  of  any  sort,  as- 
cending, descending,  or  level.  Most  would  go  in  waves  of 
greater  or  less  period  and  amplitude,  intervals  of  modera- 
tion or  even  abstemiousness  alternating  with  "  blow-outs  " 
of  various  sorts  and  degrees.  Irregularity  seems  in  fact  to 
be  a  virtue  on  its  own  account,  at  least  to  the  spirited  in- 
dividual.2 Whether  there  would  be  an  upward  or  down- 
ward trend  would  depend  also  upon  the  individual.  To 
many,  a  bird  in  the  hand  is  worth  two  or  more  in  the  bush, 

1  H.  Sidgwick  similarly  takes  the  view  that  a  preference  on  the  ground 
of  time  alone  is  irrational,  criticizing  Bentham  for  including  "propinquity" 
as  a  basis  of  preference  between  otherwise  similar  enjoyments.  See 
History  of  Ethics,  p.  241,  note.  Cf.  also  Jevons's  discussion,  Theory  of  Politi- 
cal Economy,  pp.  72  ff.,  where  the  same  position  is  taken.  Jevons's  illus- 
trative problem  of  the  consumption  of  provisions  on  a  vessel  at  sea  is 
very  effective  in  bringing  out  the  issue. 

It  will  be  noted  that  the  effect  of  the  uncertainty  of  the  future  is  very 
complex.  Against  the  chance  of  loss  of  future  enjoyment  through  death  or 
incapacitation  must  be  set  the  danger  of  future  privation  due  to  other 
contingencies.  We  are  more  likely  to  suffer  loss  of  earning  power  than  of 
power  to  enjoy,  and  the  consequences  of  need  without  ability  to  gratify 
need  are  very  unpleasant.  Perhaps  the  perfectly  rational  homo  ceconomicus 
would  discount  the  present  up  to  the  point  of  making  provision  for  the 
more  urgent  necessities  as  far  ahead  as  he  was  at  all  likely  to  live  and  dis- 
count the  future  beyond  this  point  in  increasing  degree.  The  point  is  sig- 
nificant chiefly  as  showing  the  absurdity  of  hedonistic  rationalism  as  a 
theory  of  actual  behavior. 

2  Cf.  Spencer,  First  Principles,  chap,  x,  "The  Rhythm  of  Motion." 


JOINT  PRODUCTION  AND  CAPITALIZATION    133 

while  others  take  much  thought  for  the  morrow.  Some 
children,  as  Marshall  remarks,  pick  the  plums  out  of  the 
pudding  to  eat  first,  while  others  save  them  until  the  last, 
and  many  do  not  pick  them  out  at  all;  and  adults  differ  in 
the  same  way.  The  improvidence  of  savages  is  proverbial. 
Of  course,  the  physical  conditions  of  life  set  limits  to  the 
discounting  process  in  both  directions;  we  cannot  enjoy 
to-morrow  unless  we  live  to-day,  and  many  have  learned  at 
a  cost  that  too  high  a  rate  of  living  in  the  present  may  have 
a  similar  effect  upon  the  capacity  for  future  enjoyment. 
No  generalization  in  regard  to  the  human  race  at  large 
seems  to  be  worth  making,  especially  in  view  of  the  un- 
reality of  any  simple  assumptions  as  to  the  conditions  sur- 
rounding the  choice.  The  facts  of  mere  prodigality  on  the 
one  hand  and  mere  miserliness  on  the  other  are  indispu- 
table and  may  be  studied  without  attempting  to  strike  any 
precise  balance. 

It  is  perhaps  even  more  important  at  this  point  to  in- 
sist that  the  mere  question  of  time  preference  in  consump- 
tion is  relatively  unimportant  at  best  as  an  explanation  of 
the  phenomenon  of  saving.  The  disposition  to  spend  or  to 
save,  to  consume  income  in  the  present  or  to  store  up 
wealth,  is  much  more  influenced,  in  fact,  by  other  motives.1 
Like  human  conduct  in  other  respects  it  is  mostly  a  matter 

1  It  is  fundamental  to  the  actual  phenomenon  of  capital  accumulation, 
that  the  principal,  once  saved,  never  is  consumed;  if  it  is  consumed  later, 
there  is  no  net  addition  to  the  capital  supply  of  society.  Men  save  in 
large  measure  with  no  thought  of  ever  consuming  the  capital,  or  even  the 
income  which  it  yields.  For  this  reason  the  older  term  "abstinence"! 
seems  to  me  far  more  descriptive  than  its  modern  substitute  "waiting."  [ 
To  be  sure,  an  income  of  five  dollars  a  year  in  perpetuity  represents  more 
consumption  than  one  hundred  dollars  now;  but  no  one  consumes  an  in- 
come in  perpetuity  or  expects  to  do  so.  Even  if  the  saver  consumes  the 
entire  income  from  his  investment  as  long  as  he  lives,  he  may  or  may  not 
consume  a  total  amount  equal  to  the  principal  saved.  Capital  formation 
is  the  result  of  abstinence  rather  than  waiting. 

In  fact,  the  term  "saving"  itself  is  misleading.  Men  do  not  generally 
produce  wealth  to  consume  it  and  then  decide  to  invest  it  instead.  Most 
of  that  which  is  invested  is  destined  to  that  purpose  in  the  first  place  and 
would  otherwise  never  be  produced  at  all. 


132  BISK,  UNCERTAINTY,  AND  PROFIT 

or  saving  it  all  till  the  last  day;  a  zero  time  preference  ob- 
viously means  a  uniform  distribution  in  time.  Any  piling- 
up  of  consumption  at  an  earlier  date  to  be  compensated 
by  reduced  consumption  later  on  would  be  a  real  discount 
of  the  future,  while  to  skimp  now  for  the  sake  of  plenty  or 
luxury  in  the  future  would  be  to  discount  the  present.  Of 
course,  we  abstract  from  the  element  of  uncertainty  as  to 
the  future.  We  seem  justified  in  pronouncing  either  tend- 
ency irrational  if  other  things  are  really  reduced  to  equality 
in  the  alternatives.1 

As  to  the  facts  of  human  nature  it  is  safe  to  assume  that 
different  individuals  would  give  the  most  varied  forms  of 
distribution.  Doubtless  few,  if  any,  of  these  would  con- 
form to  straight  lines  or  smooth  curves  of  any  sort,  as- 
cending, descending,  or  level.  Most  would  go  in  waves  of 
greater  or  less  period  and  amplitude,  intervals  of  modera- 
tion or  even  abstemiousness  alternating  with  "blow-outs" 
of  various  sorts  and  degrees.  Irregularity  seems  in  fact  to 
be  a  virtue  on  its  own  account,  at  least  to  the  spirited  in- 
dividual.2 Whether  there  would  be  an  upward  or  down- 
ward trend  would  depend  also  upon  the  individual.  To 
many,  a  bird  in  the  hand  is  worth  two  or  more  in  the  bush, 

1  H.  Sidgwick  similarly  takes  the  view  that  a  preference  on  the  ground 
of  time  alone  is  irrational,  criticizing  Bentham  for  including  "propinquity" 
as  a  basis  of  preference  between  otherwise  similar  enjoyments.  See 
History  of  Ethics,  p.  241,  note.  Cf.  also  Jevons's  discussion,  Theory  of  Politi- 
cal Economy,  pp.  72  ff.,  where  the  same  position  is  taken.  Jevons's  illus- 
trative problem  of  the  consumption  of  provisions  on  a  vessel  at  sea  is 
very  effective  in  bringing  out  the  issue. 

It  will  be  noted  that  the  effect  of  the  uncertainty  of  the  future  is  very 
complex.  Against  the  chance  of  loss  of  future  enjoyment  through  death  or 
incapacitation  must  be  set  the  danger  of  future  privation  due  to  other 
contingencies.  We  are  more  likely  to  suffer  loss  of  earning  power  than  of 
power  to  enjoy,  and  the  consequences  of  need  without  ability  to  gratify 
need  are  very  unpleasant.  Perhaps  the  perfectly  rational  homo  ceconomicus 
would  discount  the  present  up  to  the  point  of  making  provision  for  the 
more  urgent  necessities  as  far  ahead  as  he  was  at  all  likely  to  live  and  dis- 
count the  future  beyond  this  point  in  increasing  degree.  The  point  is  sig- 
nificant chiefly  as  showing  the  absurdity  of  hedonistic  rationalism  as  a 
theory  of  actual  behavior. 

2  Cf.  Spencer,  First  Principles,  chap,  x,  "The  Rhythm  of  Motion." 


JOINT  PRODUCTION  AND  CAPITALIZATION    133 

while  others  take  much  thought  for  the  morrow.  Some 
children,  as  Marshall  remarks,  pick  the  plums  out  of  the 
pudding  to  eat  first,  while  others  save  them  until  the  last, 
and  many  do  not  pick  them  out  at  all;  and  adults  differ  in 
the  same  way.  The  improvidence  of  savages  is  proverbial. 
Of  course,  the  physical  conditions  of  life  set  limits  to  the 
discounting  process  in  both  directions;  we  cannot  enjoy 
to-morrow  unless  we  live  to-day,  and  many  have  learned  at 
a  cost  that  too  high  a  rate  of  living  in  the  present  may  have 
a  similar  effect  upon  the  capacity  for  future  enjoyment. 
No  generalization  in  regard  to  the  human  race  at  large 
seems  to  be  worth  making,  especially  in  view  of  the  un- 
reality of  any  simple  assumptions  as  to  the  conditions  sur- 
rounding the  choice.  The  facts  of  mere  prodigality  on  the 
one  hand  and  mere  miserliness  on  the  other  are  indispu- 
table and  may  be  studied  without  attempting  to  strike  any 
precise  balance. 

It  is  perhaps  even  more  important  at  this  point  to  in- 
sist that  the  mere  question  of  time  preference  in  consump- 
tion is  relatively  unimportant  at  best  as  an  explanation  of 
the  phenomenon  of  saving.  The  disposition  to  spend  or  to 
save,  to  consume  income  in  the  present  or  to  store  up 
wealth,  is  much  more  influenced,  in  fact,  by  other  motives.1 
Like  human  conduct  in  other  respects  it  is  mostly  a  matter 

1  It  is  fundamental  to  the  actual  phenomenon  of  capital  accumulation, 
that  the  principal,  once  saved,  never  is  consumed;  if  it  is  consumed  later, 
there  is  no  net  addition  to  the  capital  supply  of  society.  Men  save  in 
large  measure  with  no  thought  of  ever  consuming  the  capital,  or  even  the 
income  which  it  yields.  For  this  reason  the  older  term  "abstinence" 
seems  to  me  far  more  descriptive  than  its  modern  substitute  "waiting." ; 
To  be  sure,  an  income  of  five  dollars  a  year  in  perpetuity  represents  more 
consumption  than  one  hundred  dollars  now;  but  no  one  consumes  an  in- 
come in  perpetuity  or  expects  to  do  so.  Even  if  the  saver  consumes  the 
entire  income  from  his  investment  as  long  as  he  lives,  he  may  or  may  not 
consume  a  total  amount  equal  to  the  principal  saved.  Capital  formation 
is  the  result  of  abstinence  rather  than  waiting. 

In  fact,  the  term  "saving"  itself  is  misleading.  Men  do  not  generally 
produce  wealth  to  consume  it  and  then  decide  to  invest  it  instead.  Most 
of  that  which  is  invested  is  destined  to  that  purpose  in  the  first  place  and 
would  otherwise  never  be  produced  at  all. 


134  RISK,  UNCERTAINTY,  AND  PROFIT 

of  social  standards,  of  what  is  "good  form,"  "the  thing" 
or  not  the  thing  to  do.  The  fact  of  possessing  an  accumula- 
tion of  goods  confers  social  prestige  and  in  addition  vast 
power  over  one's  fellows.  Even  where,  as  we  are  now  as- 
suming, productive  employment  is  not  open  to  wealth, 
the  rich  man  will  be  in  a  position  to  make  his  favor  solicited, 
his  ill-will  feared,  and  may,  of  course,  turn  his  situation  to 
material  profit  if  so  disposed.  Accumulations  are  necessary 
to  lavish  displays  or  magnificence  of  any  kind.  On  the 
other  hand,  we  must  suppose  that  where  accumulation  is 
limited  to  consumption  goods,  it  will  be  subject  to  con- 
siderable costs,  for  storage,  preservation,  protection,  and 
doubtless  inevitable  deterioration.1 

It  will  be  evident  that  differences  among  the  individual 
members  of  society  in  economic  position  and  taste  with 
reference  to  the  time  of  use  of  goods  create  a  situation  in 
which  exchange  will  be  mutually  advantageous.  To  one,  a 
present  or  early  allotment  of  goods  in  advance  of  his  own 
production  and  against  an  obligation  to  repay  later  will 
be  or  seem  a  benefit,  while  to  another,  with  an  accumulated 
and  growing  idle  stock,  a  dependable  obligation  2  for  the 
future  delivery  of  a  certain  amount  of  value,  may  be  highly 
preferable  to  the  possession  of  the  goods  themselves, 
c  If  the  balance  of  the  time  preference  in  the  population  as 
a  whole  is  in  favor  of  the  present,  no  appreciable  net  ac- 
cumulation of  goods  will  take  place.  Those  disposed  to 
accumulate  will  transfer  their  surplus  production  as  fast 
as  made  to  others  disposed  to  draw  on  the  future.  The 
conditions  of  supply  and  demand  will  establish  a  market 
ratio  of  exchange  between  present  and  future  goods  which 
in  this  case  will  show  a  premium  on  the  present,  the  magni- 
tude of  the  premium  depending  on  the  strength  of  the  ex- 

1  We  pass  over  here  the  effects  of  divergence  in  suitability  for  accumula- 
tion of  different  classes  of  goods,  due  to  differences  in  bulk,  perishability, 
universality  of  appeal,  elasticity  of  demand,  etc. 

2  We  must  here  assume  it  to  be  made  absolutely  dependable  by  in- 
surance or  otherwise. 


JOINT  PRODUCTION  AND  CAPITALIZATION     135 

cess  desire  to  anticipate  the  future.  Obviously  the  pre- 
mium on  the  present  goods  will  constitute  an  additional 
motive  for  surplus  production  and  a  deterrent  to  surplus 
present  consumption.  The  rate  established  will  be  that  at 
which  the  amount  of  surplus  present  production  will  equal 
the  amount  of  surplus  present  consumptions  The  repay- 
ment of  loans  does  not  affect  the  principles  involved,  as  it  is 
a  repetition  of  the  original  transaction  with  the  roles  of 
the  parties  interchanged.  In  the  aggregate  an  excess  of 
present  consumption  over  current  production  is,  of  course, 
impossible. 

If,  on  the  other  hand,  the  balance  of  time  preference  is 
on  the  side  of  a  disposition  to  postpone,  the  result  will  be 
an  excess  for  the  time  being  of  production  over  consump- 
tion with  net  accumulation  in  the  society  as  a  whole.  The 
exchanges  between  present  and  future  goods  will  establish 
a  premium  on  the  latter.  The  ratio  at  which  exchanges 
take  place  must  constantly  be  such  as  to  equate  the  amounts 
of  each  sort  of  service  offered  in  the  market  to  the  amount 
that  will  be  taken  at  the  price.  With  a  premium  on  future 
goods,  accumulation  will  continue  at  a  rate  depending  in 
part  on  the  amount  of  the  premium,  until  the  premium 
disappears  or  becomes  equal  to  the  cost  of  keeping  the 
accumulated  stocks.  Any  greater  premium  on  the  future 
is  impossible  as  a  permanent  thing.  But  the  conditions  of 
accumulation  might  well  be  such  that  an  indefinitely  long 
time  would  be  required  to  reach  the  equilibrium  result.  In 
that  case  the  actual  condition  at  any  time  is  a  premium  on 
the  future  with  progressive  accumulation  taking  place. 

The  " premium* '  or  time  preference  rate  under  the  con- 
ditions described,  though  similar  to  (positive  or  negative) 
interest,  must  be  distinguished  from  that  phenomenon  as  it 
is  met  with  in  modern  industrial  life;  it  is,  indeed,  an  ele- 
ment, but  a  relatively  insignificant  one,  affecting  the  in- 
terest rate  on  loans  of  productive  capital.1 

1  Wicksteed  has  an  excellent  discussion  of  this  point.  (See  Common 
Sense  of  Political  Economy,  chap,  vn.)  It  is  noteworthy  that  the  "usury" 


186  RISK,  UNCERTAINTY,  AND  PROFIT 

Time  value,  presentness  or  futureness,  is  perhaps  best 
regarded  as  a  special  sort  of  utility  in  a  good,  like  nutritive 
value  or  beauty  or  any  other  quality  conferring  or  enhanc- 
ing desirability.  The  rate  of  payment  for  it,  where  sep- 
arated from  other  considerations,  is  evidently  determined 
by  " psychological' '  considerations  on  both  the  demand 
and  supply  sides,  and  the  current  interest  theory  of  the 
psychological  school  is  based  on  a  confusion  of  this  phenom- 
enon with  interest  proper  as  a  distributive  share.  The 
subject  of  interest  proper  will  claim  attention  at  a  later 
stage  of  the  discussion.  We  shall  find  that  interest  in  the 
correct  sense  may  not  be  met  with  at  all  in  a  society  where 
uncertainty  is  absent,  even  if  accumulated  wealth  is  pro- 
ductively used  and  even  if  the  society  is  progressive  with 
respect  to  the  accumulation  of  capital,  if  knowledge  and 
foreknowledge  are  complete. 

We  may  now  return,  and  in  view  of  the  knowledge  ob- 
tained of  the  rdle  of  time  in  economic  conduct  take  up  the 
relations  of  property  in  the  simple  sense  of  productive 
agencies  separable  from  the  persons  of  their  owners  and 
subject  to  lease  and  sale.  It  must  be  borne  in  mind  that 
for  the  present  we  exclude  any  possibility  of  either  increase 
or  decrease  in  the  property  or  any  physical  change  of  such 

against  which  moralists  have  universally  thundered  in  pre-industrial  soci- 
ety corresponds  to  the  phenomenon  just  described  rather  than  to  modern 
interest.  The  productive  investment  of  accumulated  wealth  was  nearly 
unknown  in  earlier  times  and  even  the  purchase  of  existing  productive 
property  was  rare.  Practically  the  only  productive  agencies  known  were 
land  and  slaves.  Land  was  not  private  property  in  the  modern  sense  and 
was  hardly  ever  bought  and  sold  commercially,  while  slaves  were  used  al- 
most exclusively  in  connection  with  land  and  by  its  owner  even  when  not 
legally  attached  to  the  land  itself.  If  there  had  been  a  free  market  for  con- 
sumption loans  the  correspondence  with  the  phenomenon  we  have  de- 
scribed would  have  been  complete  except  for  the  element  of  risk.  The  ab- 
sence of  a  competitive  market  was  the  source  of  much  of  the  evil  of  usury, 
and  the  payments  made  doubtless  did  represent  extortion  largely.  Be  it 
observed,  also,  that  historically  speaking  modern  interest  developed  out  of 
the  consumption  loan  through  the  intermediary  of  passive  partnerships  in 
trade  ventures  and  not  out  of  dealings  in  canoes,  fish  nets,  etc.,  in  which 
the  fancies  of  a  certain  school  of  interest  theorists  are  prone  to  revel. 


JOINT  PRODUCTION  AND  CAPITALIZATION    137 

a  character  as  to  modify  its  functioning.  Such  changes 
and  their  effects  belong  to  our  third  division  of  econom- 
ics, which  deals  with  changes  in  the  conditions  of  the  pro- 
duction and  consumption  of  wealth.  To  realize  static  con- 
ditions they  must  be  abstracted.  It  will  be  convenient  to 
refer  to  property  of  the  sort  we  have  in  view  as  "land,"1 
since  land  has  been  conventionally  treated  as  if  qualita- 
tively and  quantitatively  given  once  for  all  by  nature. 
This  is  not  at  all  the  view  of  land  which  will  be  presented  in 
this  study  when  the  time  comes  to  discuss  the  subject. 
But  it  is  a  convenient  name  at  this  point  for  a  productive 
agency  of  a  certain  described  character.  We  assume,  as  a 
matter  of  course,  that  such  property  is  limited  in  amount 
(i.e.,  subject  to  "diminishing  returns")  and  that  there  is 
no  other  sort  of  property  present  in  the  society.  On  the 
production  side,  then,  the  side  of  demand,  and  in  relation 
to  functional  distribution  it  will  be  exactly  like  other  agen- 
cies (human  services),  but  its  presence  may  affect  the  per- 
sonal distribution  of  income  very  considerably. 

Supposing  the  final  adjustment  to  have  been  reached  in 
the  organization  of  production,  any  piece  of  property  such 
as  described  may  be  regarded  as  a  right  or  title  to  a  com- 
modity or  money  income  in  perpetuity.  As  such,  its  bear- 
ings on  conduct  are  closely  related  to  the  time  distribution 
of  consumption.  A  piece  of  land  represents  future  goods 
in  the  very  special  form  of  a  value  income  distributed  uni- 
formly throughout  all  future  time.  We  may  assume  with- 
out argument  that  such  a  piece  of  property  will  be  desirable 
and  that  under  conditions  of  free  contract  a  definite  mar- 
ket rate  of  exchange  between  land  and  consumption  goods 
will  be  established.  More  accurately  this  price  will  be  a 
ratio  between  the  income  from  the  land  (of  which  there  is 

1  With  the  actual  history  of  property  we  are,  of  course,  not  concerned. 
Doubtless,  the  first  approximation  to  private  productive  property  was  in 
human  beings,  slaves,  or,  perhaps,  women  or  children,  while  the  last  thing 
to  become  really  privately  owned  was  land.  But  the  proper  order  for  our 
purpose  is  not  chronological,  but  rather  that  of  increasing  complexity. 


138  RISK,  UNCERTAINTY,  AND  PROFIT 

no  significant  measure  other  than  its  income)  and  a 
quantity  of  present  goods  also  measured  in  value  terms. 
The  price  could,  therefore,  be  stated  as  a  certain  number 
of  years'  purchase  or  a  rate  per  cent  per  annum,  and  rep- 
resents the  familiar  phenomenon  of  capitalization.  Our 
present  problem  is  to  formulate  the  conditions  determining 
this  capitalization  rate. 

Land  will  be  in  demand  especially  by  persons  disposed  to 
store  up  wealth  for  future  use;  i.e.,  to  discount  the  present. 
It  is  in  effect  future  goods,  but  the  manner  of  their  distri- 
bution in  the  future  imposes  a  new  special  limitation  on 
the  conditions  of  their  demand.  We  have  seen  that  it  is 
reasonable  and  common  for  human  beings  to  prefer  future 
goods  to  present,  within  limits,  as  compared  with  a  uniform 
distribution  in  time.  Most  civilized  persons,  in  fact,  plan 
for  a  rising  standard  of  living  through  life  rather  than  a 
constant,  much  less  a  falling  one.  But  when  infinite  time 
comes  under  consideration  the  case  is  different. 

Any  finite  amount  of  consumption  or  enjoyment  dis- 
tributed uniformly  through  infinite  time  becomes  a  zero 
rate  of  real  income.  Hence  there  must  be  an  apparent 
discount  on  the  future  in  the  demand  for  perpetual  in- 
come goods.  Indeed,  it  is  self-evident  that  future  incomes 
must  be  discounted  at  some  rate  greater  than  zero  or  they 
would  have  infinite  present  worth.  The  discount  of  the 
present  in  favor  of  the  future  can  hold  good  only  for  finite 
periods  of  time  in  a  society  where  present  goods  are  limited 
at  all;  i.e.,  under  economic  conditions.  We  must  note  also, 
however,  that  when  a  capitalization  rate  and  a  market 
price  for  land  have  been  established,  the  land  will  be  con- 
vertible at  will  into  a  fund  of  present  consumption  goods. 
The  existence  of  a  free  market  for  permanent  income  goods 
makes  the  apparent  rate  of  time  preference  uniform  for  all 
real  (finite)  intervals.  The  individual  who  may  not  wish  to 
keep  on  postponing  to  the  end  of  a  long  period  knows  that 
he  does  not  need  to  do  so  unless  he  wishes;  for  at  any  time 


JOINT  PRODUCTION  AND  CAPITALIZATION    139 

he  can  realize  upon  his  accumulation  in  present  consump- 
tion form  as  rapidly  as  he  may  wish.  There  must  be  a  pre- 
mium on  present  over  future  goods  in  the  market  for  per- 
petual income  property;  but  such  a  premium,  even  if  high, 
is  not  incompatible  with  a  premium  on  the  future  over  the 
present  for  any  finite  interval,  and  might  perfectly  well 
exist  in  a  society  where  every  individual  and  the  group  as 
a  whole  distributed  its  consumption  in  time  in  a  curve 
ascending  at  any  finite  slope. 

Under  these  conditions  a  person  could  arrange,  by  the 
purchase  and  sale  of  income  property,  for  any  desired 
iistribution  of  consumption  over  any  specified  period,  or, 
through  an  appropriate  life  insurance  organization,  over 
the  uncertain  period  of  his  life.  Those  wishing  to  post- 
pone consumption,  to  secure  a  rising  distribution  of  real 
income,  would  buy  such  property  in  the  earlier  years  and 
gradually  sell  it  off  in  the  later  ones.  Those  wishing  to 
anticipate  future  production  and  secure  a  descending 
curve  of  consumption  would  progressively  sell  off  their 
land.  (Persons  possessing  no  land  could  make  the  anticipa- 
tion arrangement  only  in  the  manner  described  above  in 
discussing  a  situation  where  such  goods  were  absent.) 
The  society  as  a  whole  cannot  anticipate  future  production 
unless  there  is  some  other  society  from  which  it  can  borrow. 
It  can  postpone  in  the  aggregate  only  as  in  the  situation 
above  described,  through  an  actual  accumulation  of  con- 
sumption goods.  The  process  of  net  accumulation  would 
again  tend  toward  an  equilibrium  with  current  production 
and  consumption  equal,  though  the  goal  might  be  an  in- 
definite distance  in  the  future.  There  must  at  any  time  be 
an  equilibration  of  the  two  sorts  of  motives  through  the 
discount  rate  established,  together  with,  in  the  case  just 
mentioned,  a  certain  rate  of  net  accumulation. 

The  rate  at  which  perpetual  income  goods  are  capital- 
ized in  the  market  is  not  yet  a  rate  of  interest  in  the  sense 
of  a  distributive  share.    Nor  would  there  be  any  necessity 


140  RISK,  UNCERTAINTY,  AND  PROFIT 

under  the  conditions  we  have  described  for  lending  money 
in  connection  with  the  transfer  or  use  of  income-bearing 
property  (though  consumption  loans  might  be  effected  in 
much  the  familiar  form).  The  capital  loan  for  productive 
purposes  is,  as  we  shall  presently  see,  a  device  for  separating 
the  ownership  of  value  equities  in  production  goods  from 
the  direct  ownership  of  the  goods  themselves.  It  is  mainly 
the  presence  of  the  risk  or  uncertainty  factor  which  makes 
such  a  separation  desirable.  In  a  progressive  society  some 
motives  for  specializing  to  individuals  other  than  the  savers 
the  function  of  making  the  investment  might  exist  even  in 
the  absence  of  uncertainty.  In  the  society  which  we  have 
described  with  both  uncertainty  and  progress  absent,  there 
would  be  no  motive  for  lending  or  borrowing  value  funds 
for  the  purchase  of  productive  agencies. 


CHAPTER  V 

CHANGE  AND  PROGRESS  WITH  UNCERTAINTY 
ABSENT 

We  turn  now  to  the  third  grand  division  of  theoretical 
economics,  the  study  of  the  use  of  resources  in  the  increase 
of  resources  for  the  making  of  goods  andjn  the  refinement 
of  wants  alongside  of  and  alternative  to  their  direct  use 
in  making  goods  for  consumption.  The  relations  of  these 
three  theoretical  problems  are  somewhat  complex  and  con- 
fusions in  regard  to  them  have  been  a  prolific  source  of  error 
in  economic  thinking.  The  first  problem  is  the  use  of  given 
goods  in  the  satisfaction  of  given  wants  (with  a  given  dis- 
tribution of  the  goods  to  begin  with,  and  free  exchange) 
and  its  analysis  and  solution  constitute  the  theory  of 
market  price.  Market  prices,  besides  determining  the  ap- 
portionment of  given  stocks  of  goods,  the  product  of  past 
industry,  at  the  same  time  show  the  social  estimate  of  the 
relative  importance  of  different  goods  according  to  which 
the  apportionment  of  resources  under  the  second  problem 
is  worked  out.  In  this  first  division,  production  goods  do 
not  enter  at  all,  since  costs  already  incurred  have  no  bear- 
ing on  price;  as  Jevons  puts  it,  "bygones  are  forever  by- 
gones." 

The  second  problem  deals  with  the  use  of  given  pro- 
ductive resources  in  the  production  of  goods  to  be  used, 
(always  in  accordance  with  market  price  principles)  in  the 
satisfaction  of  given  wants;  it  has  become  known  as  the 
problem  of  the  static  society  or  "static  state,"  and  has  two 
aspects.  The  first  phase  relates  to  the  value  of  productive 
services  separately;  the  second,  to  the  values  of  particular 
consumption  goods,  in  relation  to  the  values  of  the  pro- 
ductive services  which  go  into  them,  or  their  costs;  this 


142  RISK,  UNCERTAINTY,  AND  PROFIT 

is  the  problem  of  the  long-time  or  normal  prices  of  consump- 
tion goods.  In  a  sense  it  is,  as  Marshall  suggests,  a  case  of 
two  classifications  crossing  each  other.  The  first  problem 
classifies  on  the  basis  of  consumption  goods,  showing  the 
equation  of  the  value  of  a  commodity  to  that  of  the  bundle 
of  productive  services  entering  into  it.  The  second  takes 
the  productive  service  as  a  basis  and  shows  the  equation  of 
the  value  of  each  unit  of  productive  service  to  the  value  of 
the  portion  of  each  kind  of  consumption  goods  in  whose 
creation  it  is  used,  for  which  it  is  responsible.  The  first 
is  the  long-time  "value"  problem,  the  second  is  the  short- 
time  "distribution"  problem.  The  changes  in  supply  (and 
value)  of  consumption  goods  are  studied  in  relation  to 
fixed  conditions  of  production,  including  especially  fixed 
supplies  and  methods  of  organization  of  productive  re- 
sources. 

The  third  general  problem  also  relates  to  both  value  and 
distribution  phenomena.  Changes  in  the  "fundamental 
conditions  of  demand  and  supply"  of  goods  give  rise  to 
what  Marshall  calls  "secular  changes  in  normal  price." 
But  the  principal  "fundamental  conditions"  subject  to 
change  are  the  supplies  of  the  different  productive  serv- 
ices which  evidently  affect  still  more  directly  the  prices 
of  these  services,  the  distributive  shares.  Our  discussion, 
like  Marshall's,  will  be  practically  limited  to  this  more 
simple  and  direct  effect,  the  modification  of  the  distribution 
situation,  and  its  tendency  toward  an  equilibrium.1 

1  Marshall's  organization  of  economic  theory  about  the  fundamental 
problems  is  not  very  clear.  We  have  already  seen  that  he  does  not  bring 
out  the  relations  between  market  and  normal  price  in  the  case  of  con- 
sumption goods.  He  refers  to  the  problem  of  secular  changes  in  normal 
price,  but  relegates  discussion  of  the  subject  to  later  volumes  not  yet 
published.  In  his  treatment  of  distribution  he  fails  to  make  clear  that  the 
short-time  distribution  problem  is  a  phase  of  the  same  fundamental  analy- 
sis as  normal  prices  of  consumption  goods.  Moreover,  he  has  very  little 
interest  in  this  short-time  distribution  problem.  Book  vi  of  the  Princi- 
ples is  almost  entirely  devoted  to  the  long-time  equilibrium  tendencies  of 
the  distributive  shares,  hardly  more  than  passing  notice  being  given  to  the 


CHANGE  WITH  UNCERTAINTY  ABSENT       143 

First,  let  us  try  to  formulate  clearly  and  accurately  what 
is  involved  in  the  problem  of  progress.  What  new  variables 
come  in  for  study?  What  is  the  exact  content  of  the  "gen- 
eral conditions  of  demand  and  supply,"  or  the  "given  re- 
sources used  in  the  satisfaction  of  given  wants,"  which  our 
previous  analysis  has  assumed?  And  finally,  what  are  the 
changes  in  these  factors  which  call  for  consideration  in 

conditions  of  equilibrium  from  the  standpoint  of  distribution  at  any  given 
time  or  for  short  periods  when  the  supply  is  to  be  taken  as  fixed.  Nor  does 
he  identify  or  even  explicitly  connect  the  question  of  the  long-time  tend- 
encies in  distribution  with  that  of  secular  changes  in  normal  price,  which 
are  phases  or  points  of  view  in  the  analysis  of  the  same  fundamental  prob- 
lem of  social  economic  organization.  In  the  writer's  view  the  problem  of 
intelligible  exposition  and  of  fundamental  comprehension  of  the  price  or- 
ganization can  be  greatly  lightened  by  the  recognition  and  emphasis  of 
these  lines  of  relation.  In  addition,  it  is  helpful  to  stress  the  close  analogy 
in  methodology  of  treatment  between  the  short-time  price  theory  of  value 
and  that  of  distribution,  and  similarly  with  respect  to  the  two  long-time 
or  normal  price  theories. 

In  this  connection  it  is  interesting  to  compare  Marshall  with  Professor 
J.  B.  Clark,  who  is  especially  known  in  connection  with  the  use  of  the 
static  hypothesis  in  this  country.  Clark's  organization  is  even  more  in- 
adequate, and  it  is  especially  striking  that  he  does  not  acknowledge  the 
connection  between  his  method  and  that  of  Marshall.  The  "static  state" 
of  Clark  is  the  same  problem  as  Marshall's  long-time  normal  price,  while 
his  economic  dynamics  corresponds  with  the  secular  changes  in  the  field 
of  value  and  the  long-time  tendencies  in  distribution.  But  Clark,  under 
Austrian  and  German  historical  influence  as  Marshall  was  under.  English 
classical,  gives  us  as  the  theory  of  distribution  the  short-time  analysis, 
and  hardly  goes  beyond  recognizing  the  existence  of  the  problem  of  pro- 
gressive change,  the  long-run  results  or  conditions  of  equilibrium  of  which 
are  Marshall's  almost  exclusive  concern.  He  is,  indeed,  much  less  satis- 
factory in  this  field  than  is  Marshall  in  the  short-time  theory,  for  the 
latter  does  give,  in  passing,  a  very  fair  statement  of  the  productivity 
analysis.  It  would,  of  course,  be  a  serious  error  to  confuse  Clark's  "static 
state"  with  the  "stationary  state"  of  the  classical  economists.  The 
stationary  state  of  these  writers  was  the  naturally  static  or  equilibrium 
condition,  which  is  the  goal  of  progress  or  the  subject  matter  of  the  third 
division  of  the  study,  not  a  state  made  static  by  arbitrary  abstraction  as  a 
methodological  device.  It  seems,  however,  that  virtually  all  discussion 
of  static  conditions  is  vitiated  by  the  failure  to  distinguish  adequately 
between  these  two  concepts.  And  we  still  lack  a  complete  discussion  of 
distribution  which  will  give  due  weight  to  both  the  short-time  and  long- 
time problems;  i.e.,  separate  the  assumption  of  fixed  supplies  of  pro- 
ductive agencies  from  the  assumption  that  supply  is  a  function  of  price.  A 


144 


RISK,  UNCERTAINTY,  AND  PROFIT 


order  to  bring  our  society  into  the  closest  possible  approx- 
imation to  reality?  Marshall,  whom  the  present  study 
more  closely  follows  than  it  does  any  other  writer,  seems 
to  avoid,  not  to  say  evade,  answering  this  question  ex- 
plicitly. He  does  at  one  point  begin  an  enumeration  of 
elements,  but  cuts  it  short  at  once  with  the  blanket  ex- 
pression quoted  above. l  A  well-known  explicit  list  of  static 
state  or  dynamic  factors  to  be  excluded  is  that  of  Professor 
J.  B.  Clark,  whose  name  is  especially  associated  with  the 
contrast  between  static  and  dynamic  problems  in  this 
country.  He  gives  these  five  elements  of  progress: 2 
(1)  growth  of  population;  (2)  accumulation  of  new  capital; 
(3)  progress  in  technology;  (4)  improvement  in  methods  of 
business  organization;  (5)  development  of  new  wants. 
Professor  Seager  modifies  this  list,  and  in  the  writer's  view 

rough  tabulation  of  the  natural  divisions  of  the  theory  may  help  to 
clarify  their  relations: 


Problem  I 

Given  supplies  of 
goods  and  given 
wants  to  be  satisfied. 
(The  situation  at  a 
moment.) 

Problem  II. 

Given  productive  re- 
sources and  given 
wants  to  be  satisfied. 


Problem  III. 

Use  of  resources  to 
increase  resources 
and  change  wants  as 
well  as  satisfy  exist- 
ing wants. 


Value 

(i.e.,  consumption 

goods) 


Market  price. 


Normal  price  (Mar- 
shall's long-time  nor- 
mal price).  Supply 
of  each  good  a  func- 
tion of  price. 


Secular    changes 
normal  price. 


Distribution 
(productive  serv- 
ices) 


No  problem  of  distri- 
bution involved. 


Short-time  or  market 
price  distribution  the- 
ory. (Fixed  supply  of 
thing  being  priced.) 


Long-time  or  normal- 
price  distribution  the- 
ory. Supply  a  func- 
tion of  price. 


1  Cf.  Principles  of  Economics,  6th  ed.,  p.  379. 

2  The  Distribution  of  Wealth,  chap.  v. 


CHANGE  WITH  UNCERTAINTY  ABSENT       145 

greatly  improves  it,  by  combining  the  third  and  fourth 
factors  and  adding  a  new  one,  the  impairment  of  natural 
resources  or  discovery  of  new  natural  wealth. 

It  will  aid  in  clarifying  the  issues  if  we  first  consider 
separately  the  conditions  of  demand  and  of  the  supply  of 
goods.  Conditions  of  demand  seem  to  include  the  follow- 
ing fundamental  facts : 

1.  The  population  considered  as  consuming  units;  its 
numbers  and  physical  composition  as  to  age,  sex, 
race,  etc. 

2.  The  psychic  attributes  of  the  population,  its  behavior 
attitudes  toward  the  consumption  of  all  sorts  of  goods, 
both  inherited  " instincts' '  (in  whatever  sense  such 
things  exist),  and  the  "social  inheritance "  of  habit, 
custom,  tastes,  standards,  mores,  and  what-not,  in- 
cluding, of  course,  actual  knowledge  or  beliefs  as  to 
the  real  characteristics  of  commodities.  We  must 
also  include  here  any  institutional  facts  as  to  the  con- 
trol of  the  consumption  of  some  persons  by  other 
persons,  such  as  authority  of  parents,  sumptuary 
laws,  etc. 

3.  Immediately,  the  money  income  of  the  population 
both  as  to  aggregate  amount  and  distribution.  Ul- 
timately, in  the  equilibrium  adjustment,  the  income 
and  its  distribution  depend  on  the  whole  set  of  con- 
ditions of  the  supply  of  goods,  especially  the  amount 
and  distribution  of  productive  resources  in  the  society. 
It  is  imperative  to  remember  that  the  end  result  of 
the  competitive  adjustment  depends  on  the  initial 
facts  in  all  these  respects. 

4.  For  completeness  it  is  important,  also,  to  consider 
the  given  facts  as  to  the  geographic  distribution  of 
the  population  as  consuming  units;  this  is  determined, 
of  course,  by  the  distribution  of  productive  resources 
and  of  environmental  conditions  affecting  desirability 
of  sites  for  habitation.   Differences  here  would  also 


146  RISK,  UNCERTAINTY,  AND  PROFIT 

produce  effects  ramifying  throughout  the  whole  or- 
ganization. 
Given  conditions  of  supply  include  especially  the  supply 
of  the  factors  of  production,  but  there  are  other  vital 
considerations.  We  may  classify  as  follows: 

1.  The  population  considered  as  labor  force,  numbers, 
and  composition. 

2.  The  psychic  or  behavior  attitudes,  tastes,  prejudices, 
etc.,  toward  productive  activities,  inherited  or  ac- 
quired. 

3.  Immediately,  money  income  and  its  distribution; 
ultimately,  the  distribution  of  ownership  of  produc- 
tive resources  of  every  kind.  There  is  no  difference 
between  personal  ability  and  productive  property  in 
this  respect.  It  is  obvious  that  income  affects  dis- 
position to  engage  in  productive  activities  and  enters 
as  a  variable,  independent  of  taste. 

4.  Although  it  belongs  logically  under  number  3,  or  is 
at  most  a  corollary  from  it,  we  specify  separately  the 
institutional  situation  as  to  the  meaning  and  extent 
of  private  property.  This  includes  all  facts  as  to 
(a)  control  of  the  use  of  productive  services  and  (b) 
of  valid  and  enforceable  rights  to  income.  There  is 
again  no  distinction  to  be  made  between  personal 
powers  and  other  productive  facts. 

5.  The  amount  and  form  of  material  agents  of  pro- 
duction in  existence.  Under  the  static  conditions 
hitherto  discussed  these  can  include  only  natural 
agents  in  the  narrowest  sense,  or,  what  would  amount 
to  the  same  thing,  implements  inherited  from  past 
generations,  and  in  either  case  subject  to  neither 
deterioration  nor  improvement. 

6.  The  geographical  distribution  of  productive  agencies. 

7.  The  state  of  the  arts;  the  development  of  technology, 
business  organization,  etc. 

^  t  Combining  the  two  groups  and  removing  duplication  we 


CHANGE  WITH  UNCERTAINTY  ABSENT       147 

find  the  following  factors  in  regard  to  which  change  or  the 
possibility  of  change  must  be  studied : 

1.  The  population,  numbers  and  composition. 

2.  The  tastes  and  dispositions  of  the  people. 

3.  The  amounts  and  kinds  of  productive  capacities  in 
existence,  including 

a.  Personal  powers. 

b.  Material  agents. 

i.  Given  by  nature.1 
ii.  Artificially  produced.1 

4.  The  distribution  of  ownership  of  these,  including  all 
rights  of  control  by  persons  over  persons  or  things. 
(Impersonal  control,  by  laws  or  mores,  is  indistin- 
guishable from  number  %  tastes  and  dispositions.) 

5.  Geographic  distribution  of  people  and  things.  This 
stands  in  close  relation  to  the  facts  of  technology. 

6.  The  state  of  the  arts;  the  whole  situation  as  to  science, 
education,  technology,  social  organization,  etc.  3 

Systematic  completeness  would  call  for  a  survey  of  possi- 
ble changes  in  each  of  these  elements  and  the  relation  of 
such  changes  to  both  value  and  distribution  phenomena, 
the  prices  of  consumption  goods  and  of  productive  services 
(and  in  addition  their  relations  to  the  capitalization  rate, 
the  sale  prices  of  productive  agencies).  No  such  ambitious 
program  can  be  entered  upon,  however.  We  shall  merely 
point  out  some  of  the  more  important  price  bearings  of 
changes  and  make  such  comments  as  seem  especially  sig- 
nificant in  illuminating  dark  places  in  theory.  The  point 
for  especial  emphasis  is  that  the  really  far-reaching  effects  of 
change  are  not  the  results  of  the  fact  of  change  itself,  but 
of  the  uncertainty  which  is  involved  in  a  changing  world. 
If  any  or  all  of  these  changes  take  place  regularly,  whether 
progressively  or  periodically  or  according  to  whatever 
known  law,  their  consequences  in  the  price  system  and  the 

1  This  distinction  follows  conventional  usage;  it  will  be  examined 
presently  and  shown  to  be  untenable.    (See  below,  pp.  159  ff.) 


148  RISK,  UNCERTAINTY,  AND  PROFIT 

economic  organization  can  be  briefly  disposed  of.  Through 
the  machinery  of  the  exchange  of  present  and  future  values 
all  of  them  will  be  fully  "  discounted  "  an  indefinite  time 
before  they  occur.  They  will  not  upset  human  calculations 
or  destroy  universal  perfect  equalization  of  alternatives. 
Hence,  in  particular,  changes,  if  foreseeable,  do  not  disturb 
the  prerequisites  of  perfect  competition  for  productive 
services,  bringing  about  exact  equivalence  between  costs 
and  values,  with  absence  of  profit. 

As  a  matter  of  fact  the  effects  of  changes  in  the  general 
conditions  of  the  production  and  consumption  of  goods 
upon  the  prices  of  consumption  goods  are  either  so  obvious 
or  so  complicated  and  hopeless  of  practical  prediction  that 
it  does  not  seem  worth  while  to  attempt  systematic  treat- 
ment of  them.  Our  discussion  will  be  confined  almost 
entirely  to  the  theory  of  distribution.  In  this  field,  also, 
let  us  note  that  progressive  changes  can  usually  be  fairly 
well  foreseen  and  discounted  and  their  effects  are  not 
generally  important  over  short  periods  of  time.  They  pro- 
duce relatively  little  real  disturbance  in  the  competitive 
adjustment  and  are  not  a  significant  cause  of  profit.  The 
significant  disturbances  and  sources  of  profit  are  rather 
the  short-period  and  erratic  fluctuations,  and  the  irregulari- 
ties of  progressive  change,  not  the  change  itself.  The  in- 
crease in  population  and  accumulation  of  new  capital  are 
not  disturbing  facts  to  any  appreciable  extent,  and  the  dis- 
turbances arising  from  invention  and  improvement  are  due 
to  the  local  and  spasmodic  way  in  which  they  originate, 
not  to  the  general  tendency. 

In  discussing  the  short-time  theory  of  distribution  (dis- 
tribution under  conditions  of  fixed  supplies  of  productive 
agencies)  we  have  repeatedly  emphasized  the  absence  of 
any  valid  ground  for  a  general  classification  of  productive 
agencies,  either  along  the  lines  of  the  traditional  three 
factors  or  along  any  other  lines.  That  is,  on  the  demand 
side  they  are  alike  or  differ  by  innumerable  impercepti- 


CHANGE  WITH  UNCERTAINTY  ABSENT       149 

ble  gradations,  and  for  short-time  problems  the  conditions 
of  supply  —  given  quantities  in  existence  —  are  also  ob- 
viously identical  for  all.  The  long-time  point  of  view,  how- 
ever, brings  in  the  new  question  of  changes  in  supply,  in 
regard  to  which  there  are  real  differences.  These  differences 
in  the  conditions  of  supply  afford  a  basis  for  legitimate 
classification,  somewhat  along  the  lines  of  the  tripartite 
division.  It  is  superficially  reasonable  to  recognize  three 
categorically  different  conditions  of  supply.  First  we  should 
have  agencies  whose  supply  is  given  once  for  all  even  over 
long  periods,  things  not  subject  to  increase  or  decrease, 
improvement  or  deterioration.  The  traditional  definition  of 
land  fits  this  description.  (We  do  not  here  raise  the  ques- 
tion whether  anything  exists  to  which  the  definition  ap- 
plies.) In  the  second  place,  some  productive  goods  may 
be,  and  obviously  are,  freely  reproducible  in  the  same  man- 
ner as  consumption  goods,  under  conditions  in  which  supply 
becomes  a  definite  function  of  the  price  of  their  services. 
The  traditional  view  of  capital  gives  it  this  character. 
(Again  we  make  no  assertions  as  to  the  correctness  of  the 
view.)  And  finally,  the  supply  of  still  other  agencies  may 
be  variable,  but  not  a  function  of  price,  or  not  connected 
with  price  in  an  immediate  or  direct  way.  The  traditional 
treatment  of  the  long-time  supply  of  labor  (the  merits  of 
which  are  also  reserved  for  later  examination)  differen- 
tiate it  in  this  respect  from  other  productive  powers.  This 
traditional  classification  is  not  accepted  as  valid,  even  from 
the  long-time  point  of  view,  and  will  be  criticized  at  length 
as  we  proceed.  But  the  superficial  basis  for  it  and  the  fact 
that  it  is  well  established  in  the  thought  and  terminology 
of  the  science  may  justify  taking  it  as  a  starting-point. 

The  ramifications  and  interconnections  of  effects  of  any 
particular  change  are  ultimately  rather  complicated,  and 
may  be  followed  out  until  nearly  every  aspect  of  the  ad- 
justment is  modified  in  some  way.  This  is  obviously  true 
of  the  first  of  the  static  characteristics  named.  Historically 


148  RISK,  UNCERTAINTY,  AND  PROFIT 

economic  organization  can  be  briefly  disposed  of.  Through 
the  machinery  of  the  exchange  of  present  and  future  values 
all  of  them  will  be  fully  "  discounted  "  an  indefinite  time 
before  they  occur.  They  will  not  upset  human  calculations 
or  destroy  universal  perfect  equalization  of  alternatives. 
Hence,  in  particular,  changes,  if  foreseeable,  do  not  disturb 
the  prerequisites  of  perfect  competition  for  productive 
services,  bringing  about  exact  equivalence  between  costs 
and  values,  with  absence  of  profit. 

As  a  matter  of  fact  the  effects  of  changes  in  the  general 
conditions  of  the  production  and  consumption  of  goods 
upon  the  prices  of  consumption  goods  are  either  so  obvious 
or  so  complicated  and  hopeless  of  practical  prediction  that 
it  does  not  seem  worth  while  to  attempt  systematic  treat- 
ment of  them.  Our  discussion  will  be  confined  almost 
entirely  to  the  theory  of  distribution.  In  this  field,  also, 
let  us  note  that  progressive  changes  can  usually  be  fairly 
well  foreseen  and  discounted  and  their  effects  are  not 
generally  important  over  short  periods  of  time.  They  pro- 
duce relatively  little  real  disturbance  in  the  competitive 
adjustment  and  are  not  a  significant  cause  of  profit.  The 
significant  disturbances  and  sources  of  profit  are  rather 
the  short-period  and  erratic  fluctuations,  and  the  irregulari- 
ties of  progressive  change,  not  the  change  itself.  The  in- 
crease in  population  and  accumulation  of  new  capital  are 
not  disturbing  facts  to  any  appreciable  extent,  and  the  dis- 
turbances arising  from  invention  and  improvement  are  due 
to  the  local  and  spasmodic  way  in  which  they  originate, 
not  to  the  general  tendency. 

In  discussing  the  short-time  theory  of  distribution  (dis- 
tribution under  conditions  of  fixed  supplies  of  productive 
agencies)  we  have  repeatedly  emphasized  the  absence  of 
any  valid  ground  for  a  general  classification  of  productive 
agencies,  either  along  the  lines  of  the  traditional  three 
factors  or  along  any  other  lines.  That  is,  on  the  demand 
side  they  are  alike  or  differ  by  innumerable  impercepti- 


CHANGE  WITH  UNCERTAINTY  ABSENT       149 

ble  gradations,  and  for  short-time  problems  the  conditions 
of  supply  —  given  quantities  in  existence  —  are  also  ob- 
viously identical  for  all.  The  long-time  point  of  view,  how- 
ever, brings  in  the  new  question  of  changes  in  supply,  in 
regard  to  which  there  are  real  differences.  These  differences 
in  the  conditions  of  supply  afford  a  basis  for  legitimate 
classification,  somewhat  along  the  lines  of  the  tripartite 
division.  It  is  superficially  reasonable  to  recognize  three 
categorically  different  conditions  of  supply.  First  we  should 
have  agencies  whose  supply  is  given  once  for  all  even  over 
long  periods,  things  not  subject  to  increase  or  decrease, 
improvement  or  deterioration.  The  traditional  definition  of 
land  fits  this  description.  (We  do  not  here  raise  the  ques- 
tion whether  anything  exists  to  which  the  definition  ap- 
plies.) In  the  second  place,  some  productive  goods  may 
be,  and  obviously  are,  freely  reproducible  in  the  same  man- 
ner as  consumption  goods,  under  conditions  in  which  supply 
becomes  a  definite  function  of  the  price  of  their  services. 
The  traditional  view  of  capital  gives  it  this  character. 
(Again  we  make  no  assertions  as  to  the  correctness  of  the 
view.)  And  finally,  the  supply  of  still  other  agencies  may 
be  variable,  but  not  a  function  of  price,  or  not  connected 
with  price  in  an  immediate  or  direct  way.  The  traditional 
treatment  of  the  long-time  supply  of  labor  (the  merits  of 
which  are  also  reserved  for  later  examination)  differen- 
tiate it  in  this  respect  from  other  productive  powers.  This 
traditional  classification  is  not  accepted  as  valid,  even  from 
the  long-time  point  of  view,  and  will  be  criticized  at  length 
as  we  proceed.  But  the  superficial  basis  for  it  and  the  fact 
that  it  is  well  established  in  the  thought  and  terminology 
of  the  science  may  justify  taking  it  as  a  starting-point. 

The  ramifications  and  interconnections  of  effects  of  any 
particular  change  are  ultimately  rather  complicated,  and 
may  be  followed  out  until  nearly  every  aspect  of  the  ad- 
justment is  modified  in  some  way.  This  is  obviously  true 
of  the  first  of  the  static  characteristics  named.  Historically 


150  RISK,  UNCERTAINTY,  AND  PROFIT 

the  population  question  has  been  considered  with  distribu- 
tion in  connection  with  wage  theory  through  its  relation 
to  the  supply  of  labor.  Of  course,  an  increase  of  population 
is  an  increase  in  the  demand  for  goods  and  hence  in  the 
demand  for  all  the  productive  services  including  labor  it- 
self. LBut  the  demand  for  any  productive  service  depends 
finally  upon  two  elements,  the  total  output  of  industry 
and  the  relative  importance  of  that  service  in  increasing 
the  output.  In  accordance  with  the  law  of  diminishing  re- 
turns and  the  specific  productivity  theory  based  upon  that 
law,  a  relative  increase  in  the  supply  of  labor  will  increase 
the  product  of  industry  less  than  proportionally  and  de- 
crease the  relative  productivity  of  labor.  Both  effects  tend 
to  lower  wages  per  man.  The  same  reasoning  applies  to  any 
other  productive  service  as  well  as  to  labor.  3 

Much  confusion  has  arisen  in  economic  discussion 
through  different  meanings  given  to  a  distributive  share. 
We  may  speak  of  wages,  for  example,  as  above,  as  wages 
per  man,  and  similarly  of  other  incomes  in  relation  to  the 
concrete  agency  which  produces  them.  The  problem  of 
distribution  from  this  point  of  view  Cannan  calls  "pseudo- 
distribution,"  1  seemingly  an  unfortunate  term,  for  this  is 
surely  the  phase  of  the  subject  in  which  we  have  the  great- 
est and  most  direct  interest.  The  classical  economists 
themselves,  led  by  Ricardo,  usually  centered  their  dis- 
cussion around  the  fraction  of  the  total  social  produce  re- 
ceived by  the  "factor"  under  discussion.  Another  clearly 
possible  meaning  is  the  aggregate  share  of  a  "factor" 
measured  in  absolute  terms. 

The  effect  of  an  increase  in  a  factor  (meaning  a  large 
group  of  physically  interchangeable  productive  units)  on 
the  fraction  of  the  social  income  it  will  receive,  depends  on 
the  rate  of  diminishing  returns  realized  from  the  applica- 
tion of  that  agency  to  others  in  the  vicinity  of  the  pro- 
portions already  in  existence.  If  the  increase  in  total  pro- 
1  Theories  of  Production  and  Distribution,  chap.  vn. 


CHANGE  WITH  UNCERTAINTY  ABSENT       151 

duction  is  nearly  proportional  to  the  increase  in  the  factor 
(remembering  that  it  cannot  be  equal  or  greater),  its  frac- 
tional share  will  rise;  if  much  less,  it  will  fall.  The  aggre- 
gate absolute  share  of  income  falling  to  the  agency  will  in- 
crease unless  the  falling-off  in  product  is  in  equal  or  greater 
ratio  with  the  increase  in  the  agency.  Both  points,  how- 
ever, are  rather  remote  from  the  problem  of  immediate 
interest.  If  the  income  per  unit  is  known,  the  relative  and 
absolute  shares  of  the  factor  can  more  naturally  be  deter- 
mined indirectly. 

Obviously  a  shift  in  the  amount  of  any  productive 
agency  will,  through  its  effect  on  incomes,  react  on  the  de- 
mands for  goods,  and  ultimately  affect  nearly  every  feature 
of  the  organization  of  industry  and  of  the  price  system. 
The  resulting  changes  in  the  prices  of  consumption  goods 
are  what  Marshall  calls  secular  changes  in  normal  price. 
It  does  not  seem  profitable,  if  indeed  it  is  possible,  to  dis- 
cuss these  in  the  abstract.  About  the  only  general  ob- 
servation which  seems  worth  making  is  that  those  goods  in 
whose  production  any  particular  agency  predominates  will 
tend  to  fall  in  value  as  the  supply  of  that  agency  increases, 
other  things  being  equal. 

The  really  difficult  problem  in  the  theory  of  progress 
relates  not  so  much  to  the  effects  of  particular  changes. 
These  effects,  though  complicated,  can  be  traced  out  by 
the  application  of  the  principles  of  the  market,  the  "  laws  " 
of  supply  and  demand.  The  difficulty  comes  in  the  pre- 
diction of  the  changes  themselves.  What  are  the  conditions 
of  supply  of  the  productive  services?  What  changes  in  the 
supplies  of  the  different  services  may  be  reasonably  an- 
ticipated, and  to  what  goals  or  equilibria  do  they  tend? 
The  question  is  of  especial  interest  because  it  was  in  terms 
of  these  ultimate  equilibrium  levels  that  the  classical  theory 
of  distribution  was  almost  exclusively  worked  out.  In  our 
opinion  the  meaning  of  these  equilibrium  conditions  was 
misconceived  in  classical  economics  and  their  significance 


152  RISK,  UNCERTAINTY,  AND  PROFIT 

perhaps  somewhat  overestimated.!: The  early  writers  re- 
garded the  equilibrium  condition  as  constantly  at  hand  in 
a  sense  analogous  to  the  normal  price  equilibrium  between 
the  production  and  consumption,  cost  and  value,  of  con- 
sumption goods.  Their  "  static  state  "  was,  if  not  the  actual 
condition  of  society,  a  condition  on  which  it  constantly 
verged.1  It  makes  a  great  deal  of  difference  in  the  theory 
when  we  recognize,  as  the  facts  require,  that  the  equilib- 

y  rium  is  an  indefinite  and  usually  a  very  great  distance  in 
the  future.^  The  condition  must  then  be  viewed  as  the 
theoretical  result  of  a  particular  tendency  only,  which  may 
be  modified  to  any  extent  or  reversed  by  the  effect  of  other 
tendencies,  or  the  conditions  may  be  entirely  changed  by 
unforeseen  developments  long  before  any  considerable  ap- 
proach to  the  equilibrium  has  been  made.  LThe  equilibrium, 

/  then,  in  a  particular  case,  is  not  a  result  actually  to  be 
anticipated;  a  concrete  prediction  of  the  future  course  of 
events  must  take  into  account  all  the  tendencies  at  work 
and  estimate  their  relative  importance,  and  in  addition 
must  always  be  made  subject  to  wide  reservations  for  un- 
predictable influences.;,'  In  fact,  as  we  shall  see,  the  interre- 
lations of  the  various  factors  of  progress  are  so  complicated, 
and  the  functions  themselves  are  so  inaccurately  known 
and  are  affected  by  so  many  unknown  variables,  that  defi- 
nite predictions  extending  any  considerable  distance  into 
the  future  seem  to  be  quite  out  of  the  question. 

Turning  now  to  the  question  of  the  conditions  influenc- 
ing the  progress  variables  and  of  the  changes  to  be  ex- 
pected in  regard  to  each,  we  may  begin  with  the  factor  of 
population  once  more  and  go  through  the  list.  The  plan, 
of  course,  is  not  to  investigate  hypotheses  at  random,  but 
to  inquire  seriously  about  the  facts  of  the  world  we  live  in. 
The  only  arbitrary  or  unreal  element  in  the  procedure  is 
the  selection  of  the  outstanding  dominant  features  and 
their  isolation  with  a  view  to  ascertaining  if  possible  their 
1  Mills,  Principles  of  Political  Economy,  book  iv,  chap,  iv,  sec.  4. 


CHANGE  WITH  UNCERTAINTY  ABSENT       153 

own  inherent  tendencies.  The  products  of  such  an  inquiry 
are,  like  all  theoretical  deductions,  —  all  general  principles, 
—  partial  truths  which  cannot  be  applied  uncritically,  but 
must  be  combined  according  to  circumstances  and  supple- 
mented with  empirical  data.  Historic  population  theory, 
or  Malthusianism,  pictured  laborers  as  analogous  to  a 
good  supplied  under  conditions  of  constant  cost.  Wages 
were  accordingly  held  to  tend  toward  an  equilibrium  level 
equal  to  this  cost,  the  (real  or  commodity,  not  money) 
cost  of  maintaining  a  static  population.  The  premise  was 
not,  of  course,  that  the  production  of  laborers  takes 
place  from  motives  of  pecuniary  profit,1  but  that  in  con- 
sequence of  the  physiological-psychological  law  of  popula- 
tion, the  supply  varied  in  a  strictly  analogous  way.  The 
tendency  of  wages  to  the  minimum  of  subsistence  is  in- 
deed a  natural  and  correct  deduction  from  the  tendency  of 
population  to  press  constantly  upon  the  supply  of  the 
necessaries  of  life.2 
This  early  version  of  the  theory  of  the  cost  of  labor  was 

1  It  is  a  neglected  fact  that  in  the  "lower"  strata  of  society  the  pro- 
duction of  children  is  by  no  means  so  unrelated  to  the  ordinary  economic 
calculation  as  generally  assumed.  The  age  of  marriage  and  the  size  of 
families  probably  depend  much  more  in  fact  on  the  amount  of  economic 
gain  or  loss  between  the  prospective  earning  of  children  and  the  cost  of 
their  keep  while  under  their  parents'  control  than  they  do  upon  calcula- 
tions as  to  the  possibility  of  maintaining  standards  of  living  from  one 
generation  to  another.  (Of  course,  the  two  sets  of  considerations  are  inter- 
related.) A  comparison  of  birth-rates  with  living  conditions  in  the  city 
and  country  and  in  different  social  environments,  also  a  study  of  the 
effects  of  child  labor  and  compulsory  education  laws  on  birth-rates,  are 
very  suggestive  in  this  connection. 

2  It  is  hardly  necessary  to  point  out  that  the  famous  "iron  law"  of 
wages  of  Lassalle  and  the  Marxian  socialists  is  this  classical  theory  of  the 
equilibrium  wage  taken  over  bodily,  but  with  the  logical  foundation  on 
which  it  rested  repudiated  indignantly.  If  the  tendency  of  wages  to  a 
minimum  is  based  on  a  principle  of  population,  all  schemes  of  social  re- 
organization (except  in  so  far  as  they  affect  that  principle)  are  helpless  to 
produce  any  result  save  possibly  a  temporary  amelioration,  with  a  later 
increase  in  misery.  This,  it  will  be  recalled,  is  the  very  thesis  which  the 
essay  on  population  was  originally  written  to  prove  in  answer  to  the 
millennial  hopes  held  out  by  Godwin's  Political  Justice. 


156  RISK,  UNCERTAINTY,  AND  PROFIT 

manifest  themselves  in  the  market,  and  assume  perfect 
intercommunication  and  freedom  of  movement,  the  migra- 
tion factors  would  quickly  come  to  an  equilibrium. 

The  second  of  our  progress  variables  is  the  psychological 
element,  the  dispositions  and  tastes  of  the  people.  Like  the 
number  and  composition  of  the  population,  it  affects  con- 
ditions on  both  the  consumption  and  production  sides  of 
the  problem.  Changes  and  great  changes  do,  of  course,  take 
place  in  wants  for  consumption  goods  and  in  attitudes  to- 
ward different  lines  of  productive  activity.1  Most  of  these 
changes  cannot  profitably  be  treated  as  functions  of  price 
and  no  conditions  of  equilibrium  can  be  formulated  for 
them.  They  remain  in  the  class  of  external  disturbing 
causes  little  subject  to  prediction,  especially  on  the  pro- 
duction side.  Tendencies  can  often  be  noted,  such  as  the 
"lure  of  the  city"  which  now  operates  to  increase  industrial 
production  at  the  expense  of  agriculture.  In  America  the 
irrational  preference  for  white-collar  jobs  has  raised  the 
wages  of  mechanics  above  those  of  clerical  tasks  calling  for 
much  more  ability  and  education.  Other  preferences  and 
vogues  for  particular  kinds  of  work  must  be  ^passed  over 
with  the  mere  pointing-out  that  they  are  part  of  the  given 
conditions  of  the  economic  process  and  that  changes  in 
them  have  widely  ramified  effects.  These  considerations 
apply  to  uses  of  property  as  well  as  to  personal  powers, 
though  in  a  much  less  degree. 

On  the  consumption  side  there  is  a  very  important 
problem  more  amenable  to  scientific  treatment,  though  still 
very  treacherous  to  deal  with.  We  refer  to  the  familiar 
fact  of  the  use  of  economic  resources  by  private  business 
to  develop,  create,  or  direct  consumptive  wants;  i.e.,  the 

1  Strong  social  disapproval  of  any  line  of  business  or  occupation  un^ 
doubtedly  tends  to  aggravate  any  real  evil  connected  with  it,  by  throwing 
it  into  the  hands  of  persons  (of  whom  there  is  never  any  dearth)  to  whom 
social  approval  and  disapproval  are  a  matter  of  indifference.  Conspic- 
uous examples  are  money-lending  in  the  Middle  Ages  (and  the  same  type 
of  money-lending  now)  and  the  liquor  business  in  modern  times. 


CHANGE  WITH  UNCERTAINTY  ABSENT       157 

phenomenon  of  advertising.1  The  increase  of  value  through 
advertising,  whether  informative  or  merely  persuasive, 
is  quite  parallel  to  any  other  form  of  production,  or  "crea- 
tion of  utilities. "  Such  values  are  largely  transferred  from 
other  goods,  but  except  in  so  far  as  they  result  from  a 
positive  disparagement  of  competing  commodities  they 
are  to  be  regarded  as  merely  an  additional  utility  in  the 
advertised  commodity.2 

The  business  of  want  creation  is,  of  course,  very  uncer- 
tain and  aleatory  or  "risky";  but  it  is  evident  that,  as  with 
other  changes,  in  so  far  as  the  results  of  action  can  be  fore- 
seen, competition  will  equalize  gains  with  those  in  other 
fields.  Costs  will  then  be  equal  to  values  throughout  the 
system,  the  conditions  of  profitless  adjustment  being  pres- 
ent. Whether  the  creation  of  wants  is  subject  to  diminish- 
ing returns,  the  process  consequently  tending  toward  an 
equilibrium,  where  it  would  no  longer  take  place,  or  whether 
it  is  inherently  a  perpetual  cause  making  for  continued 
change,  is  a  matter  we  cannot  discuss  on  its  merits.  The 
writer's  guess  would  favor  the  latter  alternative. 

1  Efforts  on  the  part  of  society,  the  public,  organized  and  unorganized, 
to  direct  consumption  along  approved  lines,  fall  outside  the  scope  of  a 
study  of  private  competitive  organization. 

2  Disparagement  of  competing  commodities  must  be  eliminated  from 
consideration  for  the  same  reasons  as  burglary  and  such  crude  fraud  as 
the  dispensing  of  gold  bricks,  liquozone,  etc.  It  will  be  recalled  that  we 
have  expressly  eliminated  effects  of  interests  not  represented  in  market 
transactions. 

The  suggestion  may  seem  fanciful,  but  I  find  it  impossible  to  differen- 
tiate between  elements  in  the  physical  form  and  appearance  of  a  com- 
modity which  make  no  difference  in  its  efficiency  for  the  purpose  in- 
tended (an  agreeable  color,  decorative  ornament  often  actually  interfer- 
ing with  its  uses,  fancy  containers,  etc.),  on  the  one  hand,  and  on  the 
other  an  element  of  appeal  due  to  a  high-sounding  name  or  any  other 
form  of  "puffing."  These  things  do  make  a  difference  in  the  commodity 
to  the  consumer  and  in  an  exchange  system  the  consumer  is  the  last 
court  of  appeal.  If  they  are  different  to  him,  they  are  different;  if  he  is 
willing  to  buy  one  sort  in  preference  to  the  other,  then  the  first  is  superior 
to  the  second;  it  contains  "utilities"  which  the  other  does  not  have.  I  do 
not  see  that  it  makes  any  real  difference  whether  these  utilities  are  in  the 
thing  itself  or  in  some  associated  fact. 


158  RISK,  UNCERTAINTY,  AND  PROFIT 

i  In  regard  to  the  third  progress  factor,  the  amount  of  pro- 
ductive resources  in  existence,  the  first  question  relates  to 
the  classification  of  these  resources  from  the  standpoint  of 
changes  in  supply.  We  have  shown  above  that  differences 
must  be  recognized  somewhat  along  the  lines  of  the  con- 
ventional tripartite  division,  but  we  must  emphasize  that 
the  differences  have  been  much  exaggerated  and  that 
definite  classification  along  the  traditional  lines  cannot 
be  maintained.1 

The  long-time  conditions  of  the  supply  of  labor  consist 
of  two  elements:  The  first,  the  population,  has  already 
been  discussed.  The  second  is  the  factor  of  education, 
taken  in  the  broad  sense.  Now  training,  which  results  in 
increased  productive  efficiency,  is  evidently  similar  to  a 
material  productive  agency  or  capital  good  created  by 
the  diversion  of  resources  from  present  consumptive  uses. 
Even  the  population  itself,  as  observed  above,  depends  to  a 
large  extent  upon  considerations  of  pecuniary  profit  in  the 
case  of  the  social  classes  which  subsist  mainly  by  labor. 
The  distinction  between  labor  and  capital  thus  shows  a 
tendency  to  fade  away.  A  degree  of  distinction,  indeed, 
persists.  Technical  training  cannot  be  sold  or  leased  for 
use  separate  from  its  owner,  and  cannot  in  any  direct 
sense  be  perpetuated  beyond  the  owner's  working  life. 
Capital  is  at  least  less  attached  to  its  owner's  personality 
(it  is  important  to  note  that  it  is  never  absolutely  detached) 
and  may  function  in  perpetuity.  In  addition  the  invest- 
ment in  education  is  more  affected  by  other  than  profit- 
seeking  motives,  and  in  consequence  is  not  so  closely  ad- 
justed by  effective  competition  to  equality  of  return  with 
other  forms  of  investment.2   Investment  in  the  improve- 

1  It  will  be  kept  in  mind  that  from  the  standpoint  of  short-time  prob- 
lems, where  changes  in  supply  are  not  at  issue,  and  demand  alone  deter- 
mines distributive  relations,  no  classification  at  all  is  valid. 

2  The  fact  that  so  many  opportunities  for  the  profitable  investment  of 
resources  in  the  development  of  human  potentialities  are  neglected,  and  so 
many  wasteful  investments  of  the  same  kind  made,  is  perhaps  one  of  the 


CHANGE  WITH  UNCERTAINTY  ABSENT       159 

ment  of  human  powers  is  rather  a  long-time  proposition, 
yet  does  not  look  so  far  ahead  as  many  other  forms  of  in- 
vestment; in  other  ways,  however,  it  is  subject  to  a  very 
high  degree  of  uncertainty.  After  all  there  seems  to  be  as 
much  difference  between  different  cases  or  types  of  labor 
production  and  between  different  varieties  of  material 
productive  goods  creation  as  there  is  between  the  two 
classes  of  investment  of  resources  as  types.  Jn  so  far  as  un- 
certainty is  absent  and  competition  obtains,  it  is  clear  that 
investment  will  distribute  itself  between  the  two  fields  and 
over  all  parts  of  each  in  such  a  way  as  constantly  to  equal- 
ize their  net  advantages.  Which  is  to  say  (remembering 
that  costs  merely  register  competing  attractions)  that 
with  uncertainty  absent  costs  and  values  would  be  equal 
throughout  the  system;  that  is,  there  would  be  a  perfect, 
profitless  organization  of  production  and  exchange.^ 

There  is  a  fundamental  similarity  in  the  conditions  of 
supply  of  all  the  productive  services  involving  the  in- 
vestment of  resources.  In  every  case  there  is  a  diversion  of 
productive  power  from  use  in  making  present  consump- 
tion goods  to  the  creation  of  sources  of  new  consumption 
goods  income.  A  discussion  of  the  conditions  of  equilibrium 
for  any  of  them  will  therefore  be  postponed  until  all  can  be 
dealt  with  together.  The  general  theory  of  equilibrium  in 
this  case  is  in  fact  the  long-run  theory  of  interest^ 

The  classical  economist  treated  land,  or  natural  agents, 
as  given  in  supply.  This  assumption  was  the  basis  for 
propounding  a  theory  of  rent  different  from  the  reasoning 
by  which  the  other  distributive  shares  were  explained,1 

most  serious  criticisms  of  existing  society.  The  fault,  however,  is  in  the 
family  system  rather  than  in  the  private  enterprise  organization  of  in- 
dustry in  any  sense  in  which  the  two  may  be  dissociated. 

1  The  differential  theory  of  rent  has  long  since  been  recognized  as 
applying  equally  well  to  the  other  shares.  See  J.  B.  Clark,  "Distribution 
as  Determined  by  a  Law  of  Rent,"  and  J.  A.  Hobson,  "The  Law  of  the 
Three  Rents,"  Quarterly  Journal  of  Economics,  vol.  v.  It  is  not  so  generally 
recognized  that  in  consequence  it  explains  none  of  them.  It  is  especially 
remarkable  that  the  theory  of  distribution  propounded  by  General 


160  RISK,  UNCERTAINTY,  AND  PROFIT 

and  for  positing  a  special  relation  between  rent  and  cost. 
The  definition  given  for  land  to  make  it  fit  the  description 
of  a  fixed  supply  —  the  original  and  inexhaustible  powers 
of  the  soil  —  is  indeed  drastic  in  its  limitation.  Later,  this 
dogma  of  unconditional  fixity  of  supply  was  made  the  basis 
for  the  single-tax  propaganda.  We  cannot  discuss  this 
position  at  length,  but  must  take  space  to  remark  quite 
briefly  that  it  is  utterly  fallacious.  It  should  be  self- 
evident  that  when  the  discovery,  appropriation,  and  devel- 
opment of  new  natural  resources  is  an  open,  competitive 
game,  there  is  unlikely  to  be  any  difference  between  the 
returns  from  resources  put  to  this  use  and  those  put  to  any 
other.  Moreover,  any  disparity  which  exists  is  either  a 
result  of  chance  and  as  likely  to  be  in  the  favor  of  one  field 
as  the  other,  or  else  is  due  to  some  difference  in  psychologi- 
cal appeal  between  the  fields;  i.e.,  goes  to  offset  some  other 
difference  in  their  net  advantages.  Viewing  as  a  whole  the 
historic  process  by  which  land  is  made  available  for  pro- 
ductive employment,  it  must  be  said  to  be  "prdduced"; 
i.e.,  to  have  its  utility  conferred  upon  it  in  a  way  quite  on  a 
par  with  that  which  holds  for  any  other  exchangeable  good./ 
This,  of  course,  again  abstracts  from  the  factor  of  uncer- 
tainty. In  real  life  a  large  speculative  element  is  intro- 
duced; but  this  cannot  be  said  to  differentiate  land  gener- 
ically  from  any  other  class  of  goods,  though  the  results 
are  met  with  on  an  especially  large  scale  in  the  case  of  land. 
A  new  form  of  productive  resource  has  become  of  very 
great  importance  in  modern  society,  consisting  of  special 
methods  of  production  or  exclusive  technical  processes, 
whether  patented  or  kept  secret,  or  merely  not  "yet"  ex- 
tended in  use  over  the  whole  field  of  production.   Such  a 

Francis  A.  Walker,  whose  book  was  long  a  standard  text  in  American 
colleges,  amounted  to  nothing  more  than  an  elaboration  of  the  proposi- 
tion that  each  factor  gets  what  is  left  after  the  others  are  paid.  It  is  easy 
to  show  that  the  differential  theory  when  stated  in  its  significant  form  is 
identical  with  the  specific  productivity  theory.  Cf.  A.  A.  Young,  Ely's 
Outlines  of  Economics,  3d  ed.,  pp.  415-16. 


CHANGE  WITH  UNCERTAINTY  ABSENT       161 

process  is  a  source  of  income  like  any  other  agent,  and  is 
produced  in  the  first  place  in  the  same  way,  by  the  invest- 
ment of  present  resources  (in  research  and  experiment). 
They  are  different  from  most  capital  goods,  however,  in 
that  their  cost  of  maintenance  and  multiple  reproduction 
is  so  low *  that  it  is  profitable  to  multiply  them  to  the  point 
of  becoming  free  goods,  except  in  so  far  as  they  inhere  in  the 
persons  of  their  possessors.  They  thus  tend  to  revert  to  the 
category  of  enhanced  individual  capacities,  unless  in  some 
way  "monopolized."  New  productive  processes  are  like 
natural  resources  in  being  produced  under  conditions  in 
which  the  gambling  element  is  large,  but  in  so  far  as  the 
results  of  operations  can  be  foreseen  they  also  tend  to 
equality  of  return  on  investment  in  comparison  with  other 
fields. 

We  turn,  therefore,  to  the  ordinary  and  simple  case  of 
the  investment  of  resources  in  the  creation  of  new  produc- 
tive capacities;  i.e.,  to  the  case  of  capital  goods.  In  this 
connection  we  can  conveniently  discuss  the  general  case, 
subsequently  returning  briefly  to  the  problems  of  human 
powers,  natural  agents,  and  productive  methods  just  men- 
tioned. The  argument  will  be  closely  related  to,  in  fact 
may  be  said  to  take  up  and  continue,  the  discussion  in  the 
last  chapter  on  the  subject  of  time  preference  and  the  pur- 
chase and  sale  of  productive  goods.  We  now  have  the  fur- 
ther complication  that  our  productive  goods  are  no  longer 
fixed  in  supply,  but  that  opportunity  exists  for  the  indefi- 
nite creation  of  such  goods  through  the  diversion  of  re- 
sources from  the  production  of  present  consumption  goods. 

1  Ideas  are  not,  however,  free  from  these  costs,  as  sometimes  assumed. 
Thus  A.  S.  Johnson  (Rent  in  Modern  Economic  Theory,  p.  120)  contends 
that  an  idea  cannot  be  regarded  as  productive,  because  it  is  "its  nature" 
to  multiply  itself  indefinitely.  It  would  simplify  the  problem  of  education 
if  it  were  so!  But  perhaps  we  should  wish  some  discrimination  to  be  ex- 
ercised in  the  extension  of  the  quality  to  ideas  generally!  Even  so,  if  the 
"natural"  tendency  is  obstructed,  the  idea  limited  in  application  seems 
to  be  productive  in  the  sense  in  which  anything  else  is  productive.  (See 
below,  chapter  vi.) 


162  RISK,  UNCERTAINTY,  AND  PROFIT 

For  it  will  be  seen  that  to  the  individual  the  investment  of 
present  goods  (their  use  to  pay  productive  agencies  while 
the  latter,  being  liberated  by  the  "advance,"1  devote  them- 
selves to  the  making  of  the  new  equipment)  is  equivalent  to 
their  exchange  for  productive  services  already  in  existence 
in  the  possession  of  others;  it  is  an  alternative  method  for 
securing  the  same  result.  The  previous  discussion  of  the 
motivation  involved,  therefore,  applies  to  the  present 
case;  i.e.,  it  fits  the  assumptions  usually  made  as  to  the 
motives  for  capital  formation.  We  would  emphasize  the 
importance  of  a  new  motive  not  present  in  the  former 
hypothetical  case,  the  opportunity  to  create,  which  we  hold 
to  be  a  motive  on  its  own  account  very  distinct  from,  or  at 
least  very  much  more  than,  the  mere  desire  to  possess  the 
thing  created.  However,  in  this  brief  survey,  it  seems  nec- 
essary to  abstract  from  the  complicating  factors  in  the 
motive  for  saving  and  to  treat  new  productive  equipment 
as  a  perpetual  value-income  merely  (with  the  possibility 
of  cashing  in  by  sale  at  any  time,  as  in  the  previous  case).2 

1  The  classical  writers'  view  of  capital  as  "advances  to  laborers"  was 
correct  except  for  the  failure  —  natural  from  their  labor  theory  point  of 
view  —  to  include  the  other  productive  factors  as  well  as  labor. 

2  Beyond  the  dogma  that  the  desire  to  secure  the  income  from  capital 
is  the  sole  motive  for  saving,  it  is  a  still  further  and  questionable  assump- 
tion that  the  strength  of  the  motive  varies  in  proportion  to  the  size  of  the 
income  expected  or  is  connected  with  it  by  some  simple  law.  Again  we 
make,  for  convenience,  the  conventional  simple  supposition,  merely  taking 
this  opportunity  to  record  grave  doubts  as  to  the  validity  of  any  of  this 
procedure.  The  saving  of  capital  seems  to  us  to  be  in  fact  the  result  mainly 
of  two  or  three  motives  of  which  the  desire  for  increased  consumption  of 
goods  in  the  future  is  only  one  and  probably  one  of  the  less  important. 
Like  other  acts  of  man  in  society,  it  is  largely  a  mere  matter  of  established 
social  custom,  good  form,  the  thing  to  do,  the  mores.  Then«we  must  em- 
phasize the  impulse  to  create.  Probably  the  greatest  single  source  of  sav- 
ing is  the  putting  of  income  back  into  a  business,  because  of  sheer  interest 
in  the  business  and  the  desire  to  make  it  grow.  That  the  desire  for  the  in- 
creased income  is  not  the  dominant  motive  in  much  of  this  is  proved  by 
the  fact  that  men  invest  as  desperately  in  an  enterprise  never  likely  to  be 
profitable  as  they  do  in  the  most  prosperous  concern,  and  by  the  further 
fact  that  much  of  the  reinvestment  in  society  is  made  by  directors  of  cor- 
porations who  will  not  get  the  fruits  of  the  work  for  themselves  at  all. 


CHANGE  WITH  UNCERTAINTY  ABSENT       163 

The  demand  for  capital  goods  is,  therefore,  merely  the 
demand  for  future  income,  already  discussed.  Assuming  a 
static  and  universally  known  technology,  all  forms  of  such 
goods  will  necessarily  be  kept  at  a  uniform  level  of  pro- 
ductivity in  relation  to  the  investment  necessary  to  create 
them,  and  they  can  be  treated  as  a  homogeneous  class. 
The  demand  for  capital  goods  in  industry,  like  that  for  any 
other  productive  agency,  is  subject  to  the  twofold  law  of 
diminishing  productivity  already  familiar,  and  the  more  of 
such  goods  created  the  lower  the  value  income  they  will 
yield,  in  terms  of  the  goods  themselves  measured  physi- 
cally. But  the  base  on  which  the  investor  figures  is  not  the 
physical  productive  goods  created.  These  are  as  non-ex- 
istent to  his  calculation.  He  is  interested  exclusively  in  the 
relation  between  (a)  the  amount  (i.e.,  value)  of  present 
goods  he  gives  up  and  (b)  the  size  of  the  value  income 
which  he  receives.  Hence,  we  have  in  this  case  a  really 
fourfold  law  of  diminishing  effective  demand:  (1)  The 
creation  of  producers'  goods  involves  a  diversion  of  re- 
sources from  the  making  of  consumption  goods,  and  this 
transfer  takes  place  subject  to  diminishing  physical  re- 
turns. The  sacrifice  of  a  given  amount  and  kind  of  con- 
sumption goods  makes  possible  the  creation  of  a  smaller 
amount  of  any  given  kind  of  capital  goods  the  further  the. 
process  is  carried.1  (2)  Those  productive  goods  which  are 

The  truth  is,  we  believe,  that  the  real  motives  of  human  life,  at  least  of 
those  people  who  do  big  things,  are  idealistic  in  character.  The  business 
man  has  the  same  fundamental  psychology  as  the  artist,  inventor,  or 
statesman.  He  has  set  himself  at  a  certain  work  and  the  work  absorbs 
and  becomes  himself.  It  is  the  expression  of  his  personality;  he  lives  in  its 
growth  and  perfection  according  to  his  plans. 

1  The  statement  is  applicable  to  the  other  methods  of  investing  re- 
sources —  the  development  of  new  natural  agents,  training  of  labor  and 
improvement  of  technology  —  as  well  as  to  the  creation  of  capital  goods 
in  the  narrow  sense.  The  use  of  resources  to  increase  population  in  num- 
bers appears  to  be  exceptional  as  population  subsists  upon  consumption 
goods  themselves,  and  no  change  in  the  forms  of  production  is  involved. 
This  action,  however,  is  only  to  a  very  limited  extent  a  matter  of  the  cal- 
culated exchange  of  present  for  future  goods. 


164  RISK,  UNCERTAINTY,  AND  PROFIT 

more  readily  multiplied  by  the  investment  of  resources 
must  increase  relatively  to  the  other  agents  with  which 
they  are  combined  in  production,  and  become  subject  to 
diminishing  physical  returns  in  their  use.  (3)  To  the 
extent  that  the  relatively  increased  agencies  enter  into 
the  production  of  certain  commodities  more  than  of 
others  these  commodities  will  have  their  supply  relatively 
increased  and  will  fall  in  price  relatively  to  other  com- 
modities. (4)  Finally,  as  present  goods  are  progressively 
sacrificed  to  the  creation  of  future  income,  the  relative 
preference  of  the  latter  to  the  former  must  fall  off  as  more 
of  it  becomes  available. 
,  z  Other  things  being  equal,  the  investment  of  resources 
i  should  ultimately  be  carried  to  a  point  of  equilibrium  at 
i  which  the  amount  of  value  income  and  the  amount  of 
§  present  value  which  must  be  sacrificed  to  create  it  become 
}  equal  to  every  person  in  the  system.  As  long  as  the  income 
which  can  be  produced  by  sacrificing  a  given  amount  of 
present  goods  has  a  sufficient  appeal  to  induce  new  sav- 
ings, the  new  savings  must  continue  to  be  made  and  to  re- 
duce the  amount  of  value  income  obtainable  from  a  given 
amount  of  investment.  A  point  must  ultimately  be  reached 
at  which  the  product  of  investment  is  just  attractive 
enough  to  hold  in  existence  capital  already  saved,  without 
calling  forth  new  savings.  Of  course  some  individuals  may 
at  any  time  be  consuming  capital  previously  saved,  while 
others  are  saving  and  investing,  provided  the  two  offset 
each  other.1!! 

1  A  caution  is  in  place  against  taking  this  equilibrium  as  strictly  analo- 
gous to  the  normal  price  of  a  consumption  good.  A  consumption  good  is 
destroyed  in  use.  The  equilibrium  condition  in  regard  to  it  is  equality  in 
the  rates  of  its  consumption  and  production  with  a  negligible  amount  of 
the  good  actually  in  existence.  (Durable  consumers'  goods  are,  of  course, 
capital  in  fact.)  Capital,  on  the  other  hand,  accumulates,  new  production 
being  constantly  added  to  the  whole  net  product  of  the  past.  The  equilib- 
rium in  its  case  is  a  constant  amount  in  existence,  current  production  and 
consumption  amounting  in  the  equilibrium  condition  only  to  replacement 
of  wear  and  tear.  In  this  respect  capital  is  like  gold  in  the  theory  of  its 


CHANGE  WITH  UNCERTAINTY  ABSENT       165 

j, The  above  is  a  brief  statement  of  the  "eclectic"  theory 
of  interest.  The  equilibrium  ratio  of  the  annual  value  in- 
come yielded  by  the  capital  goods  created  to  the  present 
value  sacrificed  in  creating  them  —  that  ratio  at  which  no 
further  net  conversion  (saving  and  investment)  takes 
place  —  is  the  theoretical  long-time  rate  of  interest.  It  is 
the  magnitude  toward  which,  as  Marshall  says,1  the  in- 
terest rate  constantly  "tends.';}  Of  course,  "other  things" 
must  be  assumed  to  be  "equal."  But  in  the  nature  of  the 
case  other  things  are  not  and  cannot  be  equal.  As  in- 
vestment takes  place,  the  new  income  derived  from  it 
makes  the  saving  of  any  given  amount  constantly  easier, 
thus  progressively  changing  the  conditions  of  supply  of  new 
capital.  In  addition  it  is  inconceivable  that  wants  and 
tastes,  or  even  the  state  of  the  arts,  should  remain  static 
while  such  an  adjustment  worked  itself  out.  The  theory  is 
logically  sound  if  correctly  understood.  It  describes  con- 
ditions under  which  the  interest  rate  would  not  tend  to 
change,  and  is  of  service  in  predicting  the  future  move- 
ments of  the  rate.  But  it  gives  a  very  incomplete  view  of 
the  facts  which  must  be  taken  into  account  in  an  actual 
prediction.  Changes  in  the  other  things  —  especially  the 
psychology  of  spending  and  saving  (partly  a  matter  of  the 
size  of  income)  —  in  the  given  amounts  of  agencies  not 
freely  reproducible  through  investment,  and  the  develop- 
ment of  technology,  not  to  mention  wars  and  other  catas- 
trophes —  do  in  fact  commonly  exert  quite  as  much  in- 
fluence on  the  interest  rate  as  does  the  tendency  to  equilib- 
rium due  to  progressive  saving  and  investment.2 

valuation.  It  is  like  gold,  again,  in  the  respect  which  we  proceed  to  dis- 
cuss, that  the  equilibrium  condition  is  actually  an  indefinite  distance  in 
the  future,  that  new  production  is  constant  and  sure,  but  still  small  in 
amount  in  comparison  with  the  existing  supply,  and  that,  therefore,  con- 
ditions of  production  have  a  negligible  effect  on  value  over  moderate 
periods  of  time. 

1  Principles,  6th  ed.,  p.  536. 

2  Mention  should  also  be  made  of  banking,  speculation,  and  the  vicis- 
situdes of  foreign  trade,  which  may  completely  dominate  the  rate  for  very 


166  RISK,  UNCERTAINTY,  AND  PROFIT 

But  the  most  serious  criticism  to  be  made  of  the  eclectic 

theory  as  it  is  currently  presented  (e.g.,  in  Marshall)  is  its 

failure  to  recognize  the  true  meaning  of  the  equilibrium, 

and  its  assumption  that  actual  conditions  at  a  given  time 

approach  that  state.  The  contrary  is  true;  the  case  is  similar 

to  that  of  population  already  discussed,  but  more  striking 

and  important.   At  a  given  moment  in  a  society  where  new 

investment  is  taking  place  the  rate  of  capitalization  is  the 

technical  ratio  of  conversion  of  present  goods  into  future 

income.  It  is  the  "productivity"  ratio  of  new  investment, 

the  ratio  between  the  annual  value  yield  of  the  capital 

goods  to  be  created  1  and  the  value  of  the  present  goods 

short  periods.  Passing  over  such  phenomena  as  the  call-loan  rate  and  the 
relation  of  international  transactions  to  the  interest  rate,  a  word  should  be 
said  on  the  subject  of  the  bank  rate.  An  issue  of  new  currency  by  banks 
through  an  expansion  of  loans  creates  a  momentary  new  supply  of  capital 
and,  other  things  equal,  tends  to  lower  the  interest  rate.  The  effect  is 
chiefly  limited  to  those  short-time  loans  in  which  banks  mainly  deal,  but 
perhaps  not  entirely  so.  It  is  imperative  to  recognize,  however,  that  in- 
flation produces  its  effect  through  an  actual  saving,  a  diversion  of  income 
from  present  consumption  to  capital  goods  creation.  The  new  currency 
which  the  bank  lends  to  the  investor  is  not  new  purchasing  power  from  the 
standpoint  of  society  as  a  whole.  It  is  axiomatic  in  theory  that  the  aggre- 
gate real  value  of  the  circulating  medium  is  independent  of  the  number 
of  units  of  which  it  is  composed.  When  inflation  occurs,  therefore,  pur- 
chasing power  is  not  created,  but  merely  transferred  from  the  previous 
owners  of  circulating  medium  to  the  persons  into  whose  hands  the  new 
currency  is  placed  for  its  first  expenditure.  The  enormous  r61e  played  in 
history  by  inflationism  and  the  persistence  of  the  heresy  rest  upon  the 
fact  that  the  effects  of  the  expenditure  of  the  new  money  are  more  con- 
spicuous than  the  diminished  effects  of  that  which  already  existed.  It  is 
another  case  of  the  familiar  type,  "ce  qiion  voit  et  ce  qtCon  ne  voit  pas." 

However,  it  is  to  be  emphasized  also,  that  the  psychology  of  business  is 
fundamental  in  the  economic  process  and  that  it  is  a  very  complex,  sensi- 
tive, even  treacherous  thing.  It  will  not  do  to  draw  conclusions  as  to 
policy  from  mere  cause-and-effect  reasoning  based  on  any  simple  or  reason- 
able assumptions  about  human  behavior.  Bank  loans  may,  after  all, 
create  more  demand  for  capital  than  they  supply.  But  it  is  outside  our 
plan  to  enter  into  the  intricate  problem  of  changes  in  business  conditions 
or  the  business  cycle.  Some  interesting  suggestions  in  this  field  may  be 
found  in  a  series  of  articles  on  "  Commercial  Banking  and  Capital  Forma- 
tion," by  H.  G.  Moulton  and  Myron  W.  Watkins,  Journal  of  Political 
Economy,  1918  and  1919. 

1  In  real  life,  where  uncertainty  is  present,  it  is  the  product  generally 


CHANGE  WITH  UNCERTAINTY  ABSENT       167 

sacrificed  to  create  them.  Where  the  possibility  of  con- 
version—  of  saving  and  investment  or  of  consuming 
capital  already  in  existence  through  inadequate  mainte- 
nance —  exists,  it  cannot  be  otherwise.  The  psychology  of 
saving  and  spending  can  have  no  appreciable  influence  on 
the  interest  rate  at  a  moment.  The  supply  of  capital  is  not  | 
for  short  periods  a  function  of  the  interest  rate,  but  a  fixed  I 
physical  fact.  Changes  in  psychical  attitudes  may  cause 
people  to  save  (or  consume)  a  little  more  or  a  little  less,  but 
the  effect  will  be  insignificant  in  comparison  with  the  total 
supply  and  demand  of  capital  in  the  society.  The  rate  of 
time  preference  fixes  the  rate  at  which  new  capital  ac- 
cumulates, and  influences  the  rate  of  interest  at  future 
times,  but  not  at  the  moment.  The  possibility  of  conver- 
sion impels  every  individual  to  equate  his  time  preference 
rate  to  the  existing  productivity  rate,  which  is  causal,  by 
saving  more  or  less  of  his  income  or  consuming  more  or  less 
capital  already  saved. 

There  are  no  limits  to  the  time  which  may  be  requisite 
at  any  moment  to  bring  about  the  equilibrium  adjustment, 
even  assuming  all  other  things  static.  Throughout  the 
modern  industrial  period  the  rate  of  interest  has  been 
above  the  equilibrium  level,  social  conditions  being  as  they 
are  (including  human  psychology,  the  mores,  and  especially 
the  concentration  of  income  in  a  few  hands),  as  is  proved 
by  the  fact  that  capital  has  constantly  and  rapidly  accumu- 
lated. How  long  it  would  take  to  reach  the  equilibrium,  if 

anticipated  in  the  market,  which  may  not  be  the  same  as  that  subse- 
quently realized  in  any  particular  case. 

The  correct  statement  of  the  productivity  theory  as  given  in  the  text 
-  manifestly  sidetracks  the  objection  of  Professor  Fetter  and  the  time  dis- 
count school  that  the  product  of  capital  is  not  homogeneous  with  the 
capital,  and  that  consequently  no  such  ratio  can  exist  until  the  capitaliza- 
tion process  has  been  applied  to  the  capital  itself.  Before  the  investment 
is  made  the  capital  and  its  anticipated  product  are  quite  homogeneous, 
and  it  is  in  the  market  for  capital  not  yet  invested  that  the  interest  rate  is 
determined.  Capital  goods  once  created  are,  of  course,  valued  by  capital- 
ization; this  operation  presupposes  an  interest  rate,  which  is  therefore  in 
no  wise  affected  by  the  relation  between  capital  goods  and  their  income. 


168  RISK,  UNCERTAINTY,  AND  PROFIT 

the  demand  for  capital  and  other  things  remained  con- 
stant, depends  on  the  rate  at  which  people  save  corre- 
sponding to  any  divergence  between  the  actual  interest  rate 
and  the  equilibrium  rate  (allowance  being  made  for  the  in- 
crease in  income  and  reduction  in  the  psychic  cost  of  saving) 
and  the  rapidity  of  operation  of  the  law  of  diminishing 
returns  in  the  application  of  new  capital  to  other  productive 
agencies  existing  in  society.  Historically,  of  course,  the 
other  things  have  been  so  far  from  equal  —  especially  the 
demand  for  capital  has  increased  so  rapidly  through  the 
increase  of  population  and  opening-up  of  new  natural  re- 
sources —  that  the  interest  rate  shows  an  astonishing  con- 
stancy. We  should  note,  also,  that  improvements  in  tech- 
nology generally  tend  to  economize  labor  and  land  and 
relatively  increase  the  demand  for  capital.  The  conditions 
of  equilibrium  we  can  formulate;  the  actual  course  of  the 
events  which  are  to  bring  about  those  conditions  or  the 
length  of  time  they  will  occupy  are  probably  matters  of 
pure  and  unfruitful  speculation.  It  is  quite  unnecessary  to 
believe  that  there  will  really  be  any  progress  toward  equi- 
librium, and  it  goes  without  saying  that  the  failure  of 
such  progress  to  occur  militates  against  neither  the  logical 
soundness  nor  the  practical  utility  of  the  theory  itself. 

The  above  analysis  does  not  refer  to  an  interest  rate  in 
the  ordinary  sense  of  the  term,  but  merely  to  a  capitaliza- 
tion rate  or  ratio  of  exchange  between  present  consump- 
tion goods  and  income  property  which  is  also  the  ratio  of 
productivity  of  investment  to  the  investment  where  the 
opportunity  for  investment  is  open.  It  is  not  clear  whether 
the  phenomenon  of  lending  free  capital  at  interest  would  be 
met  with  in  a  society  where  uncertainty  was  absent.  The 
capital  loan  is  an  institution  or  device  for  separating  the 
ownership  of  the  value  of  a  productive  agent  from  the 
ownership  of  the  concrete  thing  itself.  The  principal,  if  not 
the  only  significant  motive  for  this  separation,  is  the  un- 
certainty as  to  future  changes  in  the  value  of  the  agents. 


CHANGE  WITH  UNCERTAINTY  ABSENT       169 

Where  this  value  is  not  subject  to  change,  or  where  it  is 
variable,  but  the  variations  are  predictable,  the  sale  price 
of  the  agency  will  inevitably  be  such  as  to  make  it  a  mat- 
ter of  complete  indifference  to  a  prospective  user  whether 
he  leases  the  agency  or  buys  it  with  borrowed  funds.  The 
loan  contract  is  an  alternative  to  a  rental  contract.  Pro- 
ducers borrow  capital  and  invest  it,  converting  it  into  pro- 
ductive goods  by  "advancing"  it  to  laborers,  landlords, 
and  capitalists,  who  furnish  the  resources  to  make  the  new 
equipment.  It  is  apparent  that  the  original  owner  of  the 
capital  could  just  as  well  invest  it  himself  and  lease  the 
agencies  thus  created  as  to  lend  the  money.  Investment 
would  be  a  practically  costless  operation  in  a  world  where 
the  future  was  perfectly  foreknown.  However,  it  may  be 
reasonable  to  suppose  that  the  inevitable  minimum  of  care 
and  trouble  would  be  sufficient  to  specialize  the  investment 
function  and  separate  it  from  the  furnishing  of  the  capital. 
If  so,  the  capital  loan  and  interest  proper  would  appear, 
the  rate  of  interest  being,  of  course,  the  capitalization  and 
productivity  ratio  just  discussed  (less  pay  for  investment 
costs  if  these  were  appreciable). 

After  investment  is  once  made  we  have  already  ob- 
served that  the  income  is  simply  a  matter  of  the  value 
yield  of  the  goods,  and  the  value  of  the  agency  is  deter- 
mined by  capitalization  of  this  yield  at  the  interest  rate 
determined  in  the  market  for  free  capital.  But  with  freely 
reproducible  productive  goods  this  value  can  never  di- 
verge appreciably  from  the  cost  of  production.  Capital 
goods  in  fact  differ  widely  in  the  length  of  time  required 
to  adjust  supply  to  changes  in  demand.  If  there  are  any 
agencies  not  subject  to  reproduction  through  investment 
at  all,  they  conform  to  the  classical  description  of  land.  It 
is  the  writer's  view  that  such  agents  are  practically  negli- 
gible and  that  in  the  long  run  land  is  like  any  other  capital 
good.  Investment  in  exploration  and  development  work 
competes  with  investment  in  other  fields  and  is  similar  in 


170  RISK,  UNCERTAINTY,  AND  PROFIT 

all  essential  respects  to  other  production  costs.  The  dis- 
tinction between  goods  relatively  flexible  and  those  rela- 
tively inflexible  in  supply  and  the  recognition  of  a  special 
category  of  income  (Marshall's  "quasi-rent ")  for  the  latter 
is  possibly  expedient.  With  uncertainty  absent  such  a  dis- 
tinction is,  of  course,  irrelevant. 

We  must  deal  briefly  with  the  remaining  items  in  the  list 
of  factors  assumed  invariable  in  discussing  the  static  state. 
The  fourth  was  the  distribution  of  ownership  of  productive 
services.  The  only  points  to  be  noted  here  are  that  the 
condition  affects  personal  powers  (labor)  in  precisely  the 
same  way  as  property,  and  that  the  facts  depend  entirely 
on  social  institutions.  It  is  only  because  we  have  been 
accustomed  to  it  that  we  think  in  terms  of  rights  to  income 
from  either  inherited  property  or  inherited  ability.  Nor  is 
it  any  more  inevitable  that  out-and-out  ownership  (nearly 
unlimited  right  of  control  plus  right  to  entire  income) 
should  be  conferred  even  for  his  own  lifetime  upon  an  in- 
dividual who  by  the  investment  of  present  income  has 
developed  productive  powers,  whether  in  his  own  person, 
or  in  produced  capital  goods,  or  by  the  discovery  and 
development  of  natural  resources.1  That  we  should  sepa- 
rate the  two  categories  in  our  thinking,  taking  property 
rights  for  granted  in  the  case  of  inherited  personal  powers 
and  stigmatizing  the  yield  of  inherited  material  goods  as 
"unearned  income"  seems  to  be  quite  inexplicable.  So- 
ciety will  always  have  to  find  some  way  to  encourage  the 

1  It  is  noteworthy  that  in  the  fourth  great  field  for  the  investment  of 
resources,  the  improvement  of  productive  methods  through  research  and 
experiment  (we  are  not  including  the  numerical  increase  of  population) 
perpetual  rights  to  the  earnings  of  the  improvement  are  not  conferred 
upon  the  person  who  makes  the  advance.  The  individual  may  retain  a 
monopoly  on  his  idea  as  long  as  he  can  keep  it  secret  or  otherwise  prevent 
its  being  copied,  but  this  is  usually  quite  impracticable  for  any  length  of 
time.  In  the  case  of  specified  sorts  of  technical  inventions,  society  con- 
fers and  protects  a  temporary  monopoly  in  the  form  of  a  patent.  (In  the 
United  States  we  find  a  growing  tendency  to  limit  the  method  of  exploita- 
tion of  even  this  temporary  monopoly.  Witness  the  prohibition  of  tying 
contracts.) 


CHANGE  WITH  UNCERTAINTY  ABSENT       171 

development  and  serious,  interested  use  of  productive 
capacities  of  all  sorts  (as  it  may  always  have  to  recognize 
family  relationships  in  securing  continuity  of  control  from 
one  generation  to  another).  But  many  other  ways  are  con- 
ceivable for  doing  these  things,  though  their  practical 
availability  is  not  a  subject  for  discussion  here.  It  is  to  be 
noted  that  society  is  now  progressing  rapidly  in  the  limita- 
tion of  ownership,  on  both  the  control  and  income  sides; 
more  and  more  restrictions  are  being  thrown  around  the  use 
of  property  and  the  conditions  under  which  an  individual 
may  agree  to  work,  and  more  and  more  income  is  being 
taken  through  taxation  for  "social"  purposes. 

In  regard  to  geographical  distributions  —  much  might 
be  said  on  this  neglected  topic,  but  space  and  the  plan  of 
this  work  do  not  permit.  The  question  of  mere  concentra- 
tion of  population,  irrespective  of  where  it  is  concentrated, 
i.e.,  of  city  versus  country,  is  far-reaching  and  fascinating. 
Immigration  and  emigration  and  internal  migration  are  ob- 
viously important  and  intricate  problems.  In  this  field 
also  we  can  recognize  the  condition  of  an  ultimate  equilib- 
rium wherein  the  advantages  of  all  locations  would  be 
equalized;  and  here  also  progress  toward  the  theoretical 
goal  is  slow  in  comparison  with  the  interval  which  separates 
us  from  it  at  any  particular  time.  Changes  in  wants,  and 
activities  directed  to  change  wants  from  motives  of  pri- 
vate gain,  are  especially  important  in  this  connection.  It  is 
hardly  too  much  to  say  that  the  political  as  well  as  eco- 
nomic history  of  America  has  been  dominated  by  real 
estate  speculation  and  by  the  cheap  money  controversy, 
largely  an  offshoot  from  the  former.  The  actual  distribu- 
tion of  population  is,  of  course,  largely  determined  by  the 
distribution  of  natural  productive  resources  and  by  the 
topography  of  the  country  in  relation  to  transportation; 
partly  also  by  mere  desirability  of  locations  for  residentM 
purposes.  But  it  is  interesting  to  observe  that  considera- 
tions of  consumption  and  social  motives  alone  would  prob- 


172  RISK,  UNCERTAINTY,  AND  PROFIT 

ably  bring  people  together  in  groups  of  all  sizes  and  degrees 
of  compactness  even  in  a  world  whose  physical  conditions 
were  absolutely  uniform. 

Static  conditions  include  finally  static  technology  and 
knowledge  in  general,  and  this  is  one  of  the  most  treacher- 
ous concepts  of  all  as  a  subject  for  scientific  discourse. 
Activities  directed  to  the  increase  of  knowledge  may  be 
very  productive,  but  it  is  too  great  a  strain  on  the  imagina- 
tion to  try  to  think  of  their  results  as  being  predictable  in  a 
particular  case.  We  have,  however,  an  approach  to  pre- 
dictability in  large  groups;  in  many  fields  research  can  even 
now  be  carried  on  more  or  less  "  intelligently "  where  the 
scale  of  operations  is  sufficiently  large.  It  seems  almost 
fanciful  also  to  speak  seriously  of  a  condition  of  equilibrium 
where  the  rewards  or  chances  of  reward  from  further  effort 
would  no  longer  be  adequate  to  entice  productive  energy 
into  this  field.  But  it  is  clear  that  even  here,  in  so  far  as  re- 
sults can  be  foreseen,  resources  will  be  distributed  so  as  to 
secure  equality  of  return  over  the  whole  field  of  investment 
and  under  competition  every  value  realized  will  be  just 
equal  to  the  cost  incurred  in  creating  it.  In  this  field  un- 
certainty is  indeed  an  inevitable  concomitant  of  progress. 
Yet  there  is  an  approach  to  predictability,  a  variation  in 
the  amount  of  unpredictability  independent  of  variation 
in  the  amount  of  progress  and  the  two  factors  must  be 
separated  in  the  causal  analysis,  for  their  effects  are  very 
different. 

CThis  completes  the  list  of  progressive  changes.  In  every 
case  the  necessary  and  sufficient  condition  of  a  perfect, 
remainderless  distribution  of  the  product  of  industry 
among  the  agencies  causally  concerned  in  creating  it,  in 
addition  to  perfect  competition  itself,  is  that  the  change 
can  be  anticipated  over  the  period  of  time  to  which  pro-  » 
ducers'  calculations  relate.  Where  the  results  of  the  em- 
ployment of  resources  can  be  foreseen,  competition  will 
force  every  user  of  any  productive  resource  to  pay  all  that 


CHANGE  WITH  UNCERTAINTY  ABSENT       173 

he  can  afford  to  pay,  which  is  its  net  specific  contribution  to 
the  total  product  of  industry.  No  sort  of  change  interferes 
with  the  no-profit  adjustment  if  the  law  of  the  change  is 
known.  3 


t 
tt 


CHAPTER  VI 

MINOR  PREREQUISITES  FOR  PERFECT 
COMPETITION 

cIn  Part  Two  we  have  attempted  an  analytical  construction 
of  a  perfectly  competitive  society,  with  a  view  to  drter- 
v-  mining  the  precise  meaning  of  the  theoretical  tendenc^s  of 
a  private  property,  free  exchange  organization  of  so<Pety, 
and  especially  the  conditions  necessary  to  the  realizat -%  of 
those  tendencies. 3The  abstract  conditions  first  enume  ated 
in  chapter  in  represented  in  part  divergencies  in  ^gree 
only  from  real  life,  and  were  in  part  arbitrary  abstractions 
from  fundamental  characteristics  of  the  pecuniary  or- 
ganization made  for  the  purpose  of  a  separate  study  of  the 
constituent  elements.  Those  of  the  latter  type  have  been 
dealt  with  in  chapters  rv  and  v,  and  the  result,  up  to  the 
present  point,  is  an  outline  picture  of  the  essentials  of  a 
perfect  competitive  system.1  The  first,  rather  preliminary, 
objective  of  the  study  has  thus  been  achieved,  as  far  as  the 
author  is  prepared  or  feels  it  advisable  to  go.  The  second 
and  more  fundamental  purpose  is  to  contrast  this  ideal, 
perfect  competition  with  the  facts  of  ordinary  life,  to  ex- 
amine the  limitations  of  the  general  principles  developed, 
and  to  inquire  as  to  the  directions  in  which  they  must  be 
supplemented  by  detailed,  empirical  data  before  com- 
pletely applicable  conclusions  can  be  drawn. 

1  There  is  one  important  exception  to  this  statement.  As  observed  in 
chapters  i  and  n,  the  presence  of  uncertainty  in  regard  to  individual 
events  does  not  necessarily  obstruct  the  workings  of  competition  or  pre- 
vent the  realization  of  its  theoretical  result  in  a  remainderless  distribution 
of  the  product  of  industry  among  the  productive  agents.  If  the  uncer- 
tainty in  a  particular  case  is  measurable,  it  may  in  effect  be  eliminated  by 
the  grouping  or  clubbing  of  a  sufficient  number  of  cases  to  secure  cer- 
tainty in  regard  to  the  group.  This  point  cannot  be  dealt  with  until  after 
the  general  theory  of  risk  and  uncertainty  has  been  presented.  (See 
chapter  vm.) 


PREREQUISITES  FOR  PERFECT  COMPETITION    175 

But  it  is  not  the  intention  to  cover  this  field  with  any 
great  degree  of  exhaustiveness.  Only  one  of  the  theoretical 
simplifications  is  to  be  studied  in  detail,  the  assumption  of 
perfect  knowledge.  Part  Three  of  the  essay  will  be  devoted 
to  a  discussion  of  the  meaning  and  consequences  of  uncer- 
tainty, the  incompleteness  and  inaccuracy  of  the  beliefs 
and  opinions  upon  which  economic  conduct  is  based.  But 
it  is  desirable  to  have  as  a  background  some  brief  notice  of 
the  other  abstracted  factors.1 

It  will  readily  be  seen  that  many  of  the  objections  to  the 
pure  theory  of  distribution  commented  upon  in  chapter  iv 
relate  to  these  necessary  scientific  idealizations,  and  have 
real  significance  as  limitations  on  the  completeness  and 
accuracy  of  the  generalizations  of  theory.  They  are  not, 
therefore,  valid  objections  to  the  theory  and  have  been 
advanced  as  such  only  because  of  the  common  failure  to 
comprehend  the  nature  of  scientific  reasoning,  the  mean- 
ing and  use  of  general  principles.  This  is  especially  ap- 
plicable to  the  first  point  to  be  noticed,  the  assumption  of 
continuous  variability  in  the  magnitude  of  all  factors  dealt 
with.  The  question  of  the  size  of  the  "marginal  unit"  is 

1  Specifications  numbered  (2)  and  (5)  in  chapter  in  —  that  people  are 
perfectly  rational  and  that  there  is  perfect  intercommunication  among 
them  —  are  clearly  phases  of  the  problem  of  perfect  knowledge  to  be 
taken  up  in  Part  Three.  In  the  present  chapter  we  are  concerned  espe- 
cially with  numbers  (3)  and  (4)  —  formal  freedom  of  action  and  perfect 
mobility,  implying  perfect  divisibility;  (6)  and  (7)  the  absence  of  mono- 
poly and  predation.  Numbers  (8),  (9),  (10),  and  (11)  have  already  been 
considered,  but  some  further  remarks  will  be  in  place  in  regard  to  the 
first  point  mentioned  under  number  (8),  the  relations  of  social  as  con- 
trasted with  individual  wants.  We  may  note  here  that  the  timelessness 
of  the  production  process  necessary  to  secure  perfect  mobility  has  been 
dealt  with  in  one  aspect  in  chapter  iv.  In  addition  it  retards  the  speed  of 
readjustments  by  holding  productive  forces  committed  to  certain  uses  for 
an  interval  after  it  would  otherwise  be  profitable  for  them  to  change. 
But  it  does  not  affect  the  final  results,  the  character  of  adjustment  when 
achieved.  Some  discussion  of  the  intermediate  effects  is  necessary  in 
connection  with  the  study  of  profits,  and  the  whole  subject  of  "friction" 
will  be  gone  into  after  the  treatment  of  uncertainty  has  cleared  the  way 
for  a  discussion  of  profit. 


176  RISK,  UNCERTAINTY,  AND  PROFIT 

clearly  relative  to  that  of  the  flexibility  of  industrial  organ- 
ization, and  the  two  must  be  considered  together.  When  we 
give  up  the  illicit  procedure  of  funding  productive  agents 
into  "factors"  and  deal  with  the  actual  competing  units  on 
their  own  account,  this  problem  becomes  of  practical  sig- 
nificance and  constitutes  an  effective  limitation  on  the  ap- 
plication of  the  theory.'  In  the  case  of  labor  especially,  with 
which  we  are  here  particularly  concerned,  the  human  in- 
dividual is  a  very  effective  unit;  not  only  does  he  bargain 
as  a  unit,  but  he  cannot  practically  be  divided  up  between 
different  establishments,  and  the  range  of  occupations  in 
which  he  can  engage  in  any  short  interval  of  time  is  also 
very  narrowly  restricted.  He  may  also  be  in  a  high  and 
surprising  degree  unique;  he  does  not  always  shade  off  by 
imperceptible  gradations  from  one  variety  to  another  to 
the  extent  that  perfect  competitive  imputation  demands. 
His  numbers  (in  proportion  to  the  number  of  variants) 
are  not  nearly  always  so  large  as  to  make  an  individual  a 
negligible  fraction  of  a  group  of  similars.1 

As  a  consequence  of  the  appreciable  dimensions  of  the 
natural  agent,  the  flexibility  of  the  economic  organization 
as  a  whole  is  restricted,  and  the  criticism  made  by  Mr.  J. 
A.  Hobson  and  Professor  Wieser  against  the  productivity 
theory  is  true  to  a  considerable  extent  in  many  individual 
cases.  There  are  many  productive  organizations  consisting 
of  small  numbers  of  rather  unique  agents  which  very  effec- 
tively supplement  each  other  and  are  not  so  effectively 
demanded  elsewhere.  In  such  a  case  competition  does  not 
afford  means  of  distributing  the  entire  yield  of  the  group 
among  its  members;  an  appreciable  part  of  it  resists  auto- 
matic division  and  remains  a  joint  product,  dependent  on 

1  It  is  not  necessary  that  he  be  an  infinitesimal  fraction  of  the  pro- 
ductive power  of  a  particular  establishment.  The  imputation  process 
works  itself  out  through  the  competition  of  establishments  for  the  differ- 
ent agents.  If  a  number  of  establishments  exist  in  which  a  certain  type  of 
agencies  is  on  an  indifference  margin,  the  income  of  all  similar  agencies 
will  be  accurately  determined. 


PREREQUISITES  FOR  PERFECT  COMPETITION    177 

the  peculiar  effectiveness  of  the  particular  organization. 
Many  partnerships  illustrate  this  point.  Imputation  goes 
as  far  as  the  group,  giving  that  its  proper  income,  but  fails 
to  distribute  accurately  within  it.  In  case  of  a  partnership 
this  division  between  the  members  is  usually  made  on 
ethical  grounds  or  on  the  basis  of  "bargaining  power," 
sheer  personal  force.  In  industry  at  large  the  special 
product  of  the  organization  above  that  competitively 
assigned  to  its  components  is  likely  to  go,  largely  at 
least,  to  the  entrepreneur,  though  bargaining  power  or 
the  strategic  situation  always  plays  a  large  part  in  the 
proceedings. 

The  same  factors  give  rise  to  a  peculiar  difficulty  in  deal- 
ing with  the  law  of  diminishing  returns.  When  any  agent 
is  by  its  physical  nature  or  any  particular  circumstances 
available  only  in  relatively  large  blocks,  so  that  only  a  few, 
perhaps  only  one,  is  used  in  a  single  competitive  organiza- 
tion, the  technological  features  of  particular  combinations 
may  cause  apparent  exceptions  to  the  "  law  "  at  some  points; 
these  may  be  apparent  for  certain  sections  of  the  curve  for 
the  simple  reason  that  one  element  is  not  subject  to  de- 
crease and  the  best  proportions  can  be  secured  only  by  in- 
creasing the  other  elements.  A  conspicuous  example  is  the 
case  of  railways,  the  principal  crucial  "agent"  being  the 
right  of  way.  If  the  demand  for  transportation  were  large 
enough  to  require  an  indefinite  number  of  tracks  the  curve 
would  be  smoothed  out  and  would  ultimately  show  in- 
creasing costs  from  the  other  elements  in  the  equipment. 
So  with  gas  or  water  mains,  until  a  certain  size  has  been 
reached,  and  many  similar  cases.  The  fact  of  limited  divisi- 
bility is  responsible  for  all  differences  in  the  economy  of 
operation  of  establishments  of  different  sizes.  The  amounts 
of  certain  agencies  or  elements  in  the  operations  not  being 
continuously  variable,  other  things  have  to  be  proportioned 
to  them  to  get  the  best  ratio,  thus  imposing  restrictions  on 
the  size  of  the  plant  as  a  whole.  Many,  if  not  most,  of  these 


178  RISK,  UNCERTAINTY,  AND  PROFIT 

questions  of  size  ultimately  come  back  to  the  human  being 
as  a  relatively  indivisible  unit. 

Preliminary  to  a  discussion  of  predatory  activity,  or 
acquisition  which  is  not  production,  we  must  again  refer  to 
the  question  of  the  ethical  implications  of  the  productivity 
analysis.  The  purely  causal  meaning  of  productivity  in  a 
scientific  explanation  of  economic  phenomena  is  apt  to  be 
confused  with  social  or  moral  issues  which  belong  in  an 
entirely  different  sphere.  We  have  insisted  that  the  word 
"produce"  in  the  sense  of  the  specific  productivity  theory 
of  distribution,  is  used  in  precisely  the  same  way  as  the 
word  "cause"  in  scientific  discourse  in  general.  But  the 
word  "cause"  itself  is  vague  in  ordinary  speech,  and  it  is 
natural  that  confusion  should  arise  in  regard  to  the  eco- 
nomic synonym.  For  example,  the  socialists,  with  no  lack 
of  suggestion  and  justification  from  the  loose  usage  of  words 
by  economists  of  non-socialistic  schools,  have  insisted  that 
all  wealth  is  "produced"  by  labor.  We  need  do  no  more 
than  mention  the  names  of  Smith  and  Ricardo  in  this 
connection,  while  among  contemporary  writers  Professor 
Taussig  exemplifies  the  same  practice,  expressly  stating 
that  labor  produces  all  wealth,  but  may  not  be  entitled  to 
all.1  We  should  say  that  the  reverse  is  more  correct,  that 
labor  does  not  "produce"  all  wealth,  but  may  be  entitled 
to  all,  on  ideal  grounds. 

Inasmuch  as  any  assertion  of  a  cause  and  effect  relation 
between  particular  events  is  always  (as  already  pointed 
out)  made  on  the  ground  of  some  special  human  interest  or 
"bias,"  there  is  much  justification  for  such  usage,  but  this 
only  makes  the  more  imperative,  a  clear  separation  from 
the  "scientific,"  use  of  causal  terminology.  Thus  it  is  quite 
proper  to  say,  in  ordinary  speech,  that  the  cook  "prepares  " 
the  meal,  that  the  opening  of  the  throttle  of  the  locomo- 

1  Paper  entitled  "Outlines  of  a  Theory  of  Wages,"  read  at  the  twenty- 
second  annual  meeting  of  the  American  Economic  Association.  See 
Proceedings,  pp.  143-44,  note. 


PREREQUISITES  FOR  PERFECT  COMPETITION    179 

tive  by  the  engineer  is  the  "cause"  of  the  starting  of  the 
train,  and  that  his  failure  to  see  the  signal  is  the  "cause" 
of  the  wreck  and  the  deaths  of  the  passengers.  In  an 
analogous  way  a  small  group  of  agents  might  for  some 
purposes  be  credited  with  nearly  the  whole  output  of  a 
large  establishment;  "other  things  equal,"  the  product  de- 
pends on  their  cooperation. 

But  it  must  be  evident  that  scientific  economics  cannot 
use  the  word  "produce"  in  this  sense.  The  product  of  any 
productive  service  can  for  scientific  purposes  be  only  what 
we  have  defined  it  to  be,  that  which  is  really  dependent 
upon  the  service  in  question,  that  which  can  be  produced 
by  its  aid  and  which  cannot  be  produced  without  it,  in  the 
social  situation  as  it  is,  allowing  for  the  change  in  organiza- 
tion which  would  accompany  its  withdrawal  from  use. 
It  follows  that  we  cannot  properly  speak  of  the  "product" 
of  an  economic  "factor,"  even  if  we  use  the  word  "factor" 
in  the  possibly  legitimate  sense  of  a  group  of  physically 
interchangeable  things.  The  product  of  "labor,"  "land," 
or  "capital,"  as  aggregates,  involves  a  still  more  illicit  and 
meaningless  use  of  terms.  The  only  specific  product  which 
can  be  recognized  is  that  of  a  single  agent  as  such,  an  in- 
dividual human  being  or  machine,  or  such  a  parcel  of  land 
(or  of  liquid  capital)  as  is  actually  bargained  for  and  used  in 
the  production  process  (and  for  perfect  competition  to  take 
place  it  must  be  negligible  in  size). 

More  important,  however,  is  the  error  of  attributing  any 
sort  of  moral  significance  to  economic  productivity.  It  is  a 
physical,  mechanical  attribute,  attaching  to  inanimate  ob- 
jects quite  as  properly  as  to  persons,  and  to  non-moral  or 
even  immoral  as  well  as  virtuous  activities  of  the  latter. 
The  confusion  of  causality  with  desert  is  an  inexcusable 
blunder  for  which  the  bourgeois  psychology  of  modern 
society  is  perhaps  ultimately  to  blame,  though  productivity 
theorists  are  not  guiltless.1  We  must  guard  against  think- 

1  Notably  Professor  J.  B.  Clark.  Cf .  above,  p.  109.  The  concessions  of 


180  RISK,  UNCERTAINTY,  AND  PROFIT 

ing  of  the  "natural"  adjustment  of  the  competitive  system 
as  having  any  moral  import,  though  it  is  of  course  "ideal" 
in  the  scientific  sense  of  being  a  condition  of  stability.  To 
call  it  the  "best  possible"  arrangement  is  merely  to  beg 
the  question  or  to  misuse  words.  The  natural  arrangement 
is  only  that  under  which,  with  the  given  conditions  as  to 
the  demand  and  supply  of  goods,  especially  the  existing  dis- 
tribution of  productive  power,  no  one  is  under  any  induce- 
ment to  make  any  change.  If  we  pass  over  the  question  of 
how  far  individual  wants  for  specific  things  really  domi- 
nate conduct,  and  neglect  equally  the  whole  category  of 
wants  for  certain  social  relationships  and  interests  in  other 
individuals  (not  absolutely  dependent),  and  assume  in 
addition  (we  shall  investigate  the  point  presently)  that  no 
interests  are  involved  in  any  exchange  except  those  of  the 
direct  parties  to  it  —  then  the  result  is  a  mere  mechanical 
equilibrium  of  the  pull  and  haul  of  interacting  individual 
self-interests. 

It  is  imperative  that  we  bear  in  mind  that  the  serpent's 
tail  is  always  in  the  serpent's  mouth,  that  what  the  com- 
petitive system  tends  to  give  back  is  just  what  is  put  into  it 
in  the  way  of  human  motives  and  human  powers,  natural, 
acquired,  or  conferred,  and  has  in  itself  no  moral  attribute 
whatever.  In  real  life  the  possession  of  property  (or  supe- 
rior training)  is  supposed  to  represent  saving  or  invention  or 
some  contribution  to  social  progress.  But  it  is  clear  that 
there  is  no  technical  (much  less  moral)  equivalence  between 
these  services  and  the  right  to  their  entire  fruits  in  perpetu- 
ity, and  to  confer  it  on  one's  heirs  and  assigns  forever  — 
particularly  when  we  consider  the  enormous  element  of 

Professor  J.  M.  Clark  {he.  cit.)  seem  to  me  to  cover  only  a  portion  of  the 
ground.  I  see  nothing  morally  ideal  in  a  distribution  according  to  in- 
nate personal  ability  —  certainly  not  ability  measured  by  pecuniary  de- 
mand for  its  products,  unless  the  rest  of  the  human  race  are  idealized  — 
and  suggest  that  such  a  distribution  would  yield  vastly  more  inequality, 
misery,  and  despair  than  does  the  present  order.  Nor,  in  the  abstract,  can 
I  see  any  connection  between  innate  ability  and  moral  desert.  Is  inherited 
ability  on  any  better  footing  morally  than  inherited  property? 


PREREQUISITES  FOR  PERFECT  COMPETITION    181 

pure  luck  in  all  operations  of  this  sort.  The  only  sense  and 
the  only  degree  in  which  rewards  for  service  are  ethical  is 
that  of  the  necessity  of  paying  the  reward  in  order  to  get 
the  service  performed.  From  this  point  of  view  the  only 
defense  of  most  of  the  existing  system  is  the  difficulty  of 
suggesting  a  workable  alternative. 

We  must  now  turn  again  briefly  to  the  point  mentioned 
above,  the  extent  to  which  outside  interests  not  represented 
in  agreements  between  individuals  are  affected  by  them 
(otherwise  than  through  direct  competition  in  the  market). 
The  mere  mechanical  effectiveness  of  competitive  free  con- 
tract in  producing  a  reconciliation  of  individual  interests 
under  given  conditions  depends  largely  on  the  answer  to 
this  question.  Obviously,  outsiders  may  be  affected  either 
advantageously  or  disadvantageously.  In  the  former  case 
voluntary  agreements  will  not  be  carried  far  enough  to 
secure  maximum  social  (total  individual)  advantage,  while 
in  the  latter  case  they  will  be  carried  too  far.  These  facts* 
form  the  most  important  source  of  the  need  for  social  in- 
terference. Many  services,  such  as  communication  and 
education,  not  to  mention  the  administration  of  justice, 
confer  a  general  benefit  on  the  community  in  addition  to  the 
special  benefit  to  the  individual,  and  must  be  encouraged 
by  bounties  or  actually  taken  over  and  performed  by  pub- 
lic agencies  or  they  will  not  be  developed  to  the  point  of 
maximunl  benefit.  The  most  familiar  illustrations  of  the 
opposite  case  in  our  society  relate  to  the  use  of  land  for 
purposes  which  damage  the  neighborhood,  or  are  thought 
to  do  so.  It  is  perhaps  of  nearly  equal  importance  that  im- 
provements on  land  and  industrial  developments  generally 
may  benefit  neighboring  property,  and  might  be  made 
much  more  readily  and  in  ways  involving  less  injustice  if 
there  were  some  practicable  way  of  assessing  these  benefits. 
This  is  notably  true  of  public  and  quasi-public  works, 
which  effect  enormous  uncompensated  transfers  of  values. 
It  may  be  doubted  whether  in  fact  any  agreement  between 


182  RISK,  UNCERTAINTY,  AND  PROFIT 

individuals  is  ever  made  which  does  not  affect  for  good  or 
ill  many  persons  other  than  the  immediate  parties,  and  a 
large  proportion  have  wide  ramifications  over  "society.'* 

In  this  brief  sketch  we  can  only  mention  and  insist  on  the 
fundamental  importance  of  the  fact  that  a  large  part  of 
what  men  want  relates  directly  to  other  members  of  society. 
Man  is,  after  all,  zoon  politikon  and  quite  on  a  par  with  his 
personal  needs  are  all  sorts  of  interests  in  furthering  the 
plans  of  people  whom  he  likes  and,  always  relatively  and 
generally  absolutely,  obstructing  those  of  others,  in  a  wide 
scale  of  gradations  down  to  Thackeray's  "'e's  a  furriner; 
'eave  a  'arf  a  brick  at  'im!"  or,  "kill  the  nigger!"  The 
relative  importance  of  other-regarding  motives  and  de- 
sires, directed  not  to  material  things,  but  to  forms  of  social 
relationships,  is  sure  to  be  underestimated  by  any  one 
treating  economic  phenomena  in  a  "scientific"  way. 

The  extreme  phase  of  the  problem  o{  the  moral  character 
of  the  economic  system  relates  to  positively  predatory 
activity.  Davenport,  following  Veblen,  has  stressed  the 
contrast  between  (private)  acquisition  and  (social)  pro- 
duction, making  much  of  the  hiring  of  sluggers,  assassins, 
and  incendiaries  as  part  of  the  demand  for  labor,  the  pro- 
ductivity of  burglars  and  their  implements,  and  the  like. 
It  is  not  really  very  difficult  in  most  cases  for  one  who  is 
disposed  to  do  so  to  distinguish  between  theft  or  brigandage 
and  free  contract,  and  perhaps  all  that  is  needful  to  say  of 
them  in  treating  the  theory  of  contractual  organization  is 
that  they  are  obviously  outside  of  it.  A  large  part  of  the 
critics'  strictures  on  the  existing  system  come  down  to  pro- 
tests against  the  individual  wanting  what  he  wants  in- 
stead of  what  is  good  for  him,  of  which  the  critic  is  to  be 
the  judge;  and  the  critic  does  not  feel  himself  called  upon 
even  to  outline  any  standards  other  than  his  own  prefer- 
ences upon  a  basis  of  which  judgment  is  to  be  passed.  It 
would  be  well  for  the  progress  of  science  if  we  had  less 
of  this  sort  of  thing  and  more  serious  effort  to  formulate 


PREREQUISITES  FOR  PERFECT  COMPETITION    183 

standards  and  to  determine  the  conditions  under  which 
free  contract  does  or  does  not  promote  individual  interests 
harmoniously  and  realize  social  ideals,  jjn  addition  it  is 
most  desirable  that  some  attempt  be  made  to  separate  the 
evils  for  which  the  form  of  organization  is  more  or  less 
reasonably  blamable  from  those  which  are  inherent  in 
nature  and  human  nature,  or  in  organization  as  such,  ir- 
respective of  its  formTanoTto  keep  the  question  in  view,  in 
criticizing  the  exchange  system,  of  whether  any  other  con- 
ceivable system  would  offer  any  possible  chance  for  change 
or  improvement.1 3 

1  See  Davenport,  Economics  of  Enterprise,  chap,  ix,  especially  p.  127; 
and  cf.  L.  H.  Haney,  "The  Social  Point  of  View,"  Quarterly  Journal  of 
Economics,  vol.  xxvm,  pp.  31&-21. 

Though  the  case  of  the  pickpocket  offers  no  real  difficulty  and  is  not 
likely  to  be  taken  seriously,  there  are  many  cases  where  standards  of  pro- 
ductivity are  very  hard  to  define.  Gambling,  for  example,  is  definitely 
ambiguous.  If  the  men  who  gamble  know  what  they  are  about,  play  for 
fun,  at  a  game  which  is  "fair,"  and  do  not  risk  more  than  they  can  afford 
to  pay  for  the  excitement,  I  should  say  that  the  gains  of  the  banker  rep- 
resent product.  If  all  are  interested  in  winning  only,  and  play  because 
they  expect  to  win,  I  suppose  the  operation  is  unproductive  and  produces 
a  transfer,  not  a  production  of  wealth.  It  will  doubtless  be  conceded  that 
there  is  such  a  thing  as  a  transfer  of  wealth,  distinguishable  from  pro- 
duction, or  else  receiving  gifts  must  also  be  classed  as  productive 
work! 

Other  cases  are  more  difficult  still,  since  no  clear  line  can  be  drawn 
between  being  tricked  and  gratifying  a  perverted  taste.  The  difficulty  is 
the  ultimate  impossibility  of  saying  what  one  "really"  wants.  In  cases 
where  each  knows  what  he  is  getting  and  what  he  is  giving  —  no  "compul- 
sion" (artificial  manipulation  of  alternatives)  being  present  —  and 
actually  gets  the  means  of  satisfying  his  actual  want,  we  must  hold  that 
the  operation  is  a  production  of  utility  in  the  economic  sense.  But  what 
we  may  call  "crude"  fraud  must  be  classed  outside  of  exchange  relations 
along  with  forced  transfers.  The  man  who  sells  whiskey,  patent  medicine, 
corrupt  literature  or  art,  etc.,  to  people  who  want  them  and  are  willing  to 
pay  for  them  is  productive;  but  one  who  sells  gilded  chunks  of  lead  to  un- 
suspecting rustics  for  gold  bricks  clearly  is  not.  If  the  buyer  be  in  a 
position  where  it  never  can  make  any  difference  whether  the  metal  is  lead 
or  gold  and  never  could  find  out  which  it  is,  the  action  is  hard  to  classify, 
but  we  must  consider  that  he  could  have  had  what  he  got  for  vastly  less 
money,  if  he  had  known.  Is  the  buyer  of  an  imitation  jewel  or  antique  for 
a  genuine,  and  who  never  knows  the  difference,  really  cheated?  And  sup- 
pose the  purchaser  of  Liquozone  or  Peruna  is  really  cured  of  his  (real  or 


184  RISK,  UNCERTAINTY,  AND  PROFIT 

There  is  a  close  connection  between  the  moral  aspect  of 
the  economic  order  and  the  problem  of  monopoly.  This 
subject  is  of  especial  importance  in  the  theory  of  profit, 
since  profit  has  often  been  ascribed  wholly  or  in  part  to 
monopoly  gain,  as  already  noticed  in  the  case  of  Macvane 
and  the  Clark  School.  "Monopoly"  is  a  word  used  to 
cover  things  which  for  present  purposes  must  be  kept  dis- 
tinct, and  its  meaning  must  first  be  made  clear.  Monopoly 
is  usually  denned  as  the  control  of  the  supply  of  a  com- 
modity. A  common  but  disastrous  error  is  the  confusion  of 
control  with  natural  limitation  of  supply.  We  need  not 
pause  longer  than  to  characterize  as  a  serious  misuse  of 
words  the  denomination  of  land  rent,  for  example,  as  a 
monopoly  income.  Even  J.  S.  Mill  fell  into  the  error  of 
defining  monopoly  as  limitation,  and  it  is  exemplified  in  its 
extreme  form  by  Mr.  F.  B.  Hawley,  who  virtually  calls  all 
income  due  to  the  "scarcity"  of  any  productive  resource  a 
mom^poly  return.  Now,  as  all  income,  from  the  distributive 
standpoint,  is  dependent  on  the  scarcity  of  the  agents 
which  produce  it,  and  all  in  exactly  the  same  way,  the 
meaninglessness  of  such  a  description  is  apparent.  And  of 
course  the  same  applies  to  "scarcity  income"  in  general, 
whether  called  monopoly  gain  or  not.  There  is  under  free 
competition  no  other  sort  of  income,  qualitatively  or 
quantitatively,  and  the  designation  neither  distinguishes  or 
in  any  significant  way  describes  anything. 

imaginary)  ailment!  And  suppose  he  is  not!  Was  it  the  medicine,  or  a 
cure,  that  he  really  bought? 

We  are  carried  back  to  the  already  oft-reiterated  observation  that  any 
scientific  thinking  about  conduct  presupposes  that  wants  are  given  en- 
tities, and  that  exchange  organization  of  the  satisfaction  of  wants  pre- 
supposes that  their  character  is  known.  Capricious  and  experimental  con- 
duct are  not  amenable  to  scientific  treatment  (unless  subject  to  prediction 
in  large  groups,  a  case  which  we  have  postponed  for  later  consideration). 
In  the  language  of  abstract  logic,  a  must  remain  a  throughout  the  dis- 
cussion. This  it  can  do  either  by  remaining  sensibly  unchanged  or  by 
changing  in  accordance  with  a  known  law.  The  last  alternative  reverts  to 
the  first,  since  such  a  change  can  be  thought  of  only  as  an  expression  of 
an  inner,  unchanging  attribute  of  the  thing  changing. 


PREREQUISITES  FOR  PERFECT  COMPETITION    185 

It  is  no  part  of  our  present  purpose  to  go  into  an  ex- 
haustive discussion  of  monopoly,  and  we  may  pass  over  the 
ordinary  type  of  the  phenomenon  very  briefly.  In  its 
original  meaning  the  word  signified  an  exclusive  right  to 
produce  or  sell  a  certain  commodity,  and  was  essentially  a 
legal  concept.  The  "legitimate"  representative  of  the  type 
in  modern  industry  is  the  patented  article  for  consumption 
—  not  patented  production  process  (including  machines, 
etc.),  which  will  be  considered  later.  Monopoly  may  also  be 
based  on  mere  financial  power,  on  the  threat  of  local  under- 
selling, boycott,  and  other  forms  of  "unfair  competition"; 
this  amounts  in  effect  to  a  voice  in  the  control  of  property 
owned  by  others  or  their  persons  as  well;  that  is,  to  part 
ownership.  Free  competition,  of  course,  involves  the  com- 
plete, separate  ownership  of  every  productive  agent  or 
natural  unit,  and  the  exploitation  of  every  one  in  a  way  to 
secure  its  maximum  value  yield.  Any  sort  of  violent  inter- 
ference with  competition  manifestly  contradicts  this  as- 
sumption and  may  be  roughly  designated  monopoly. 

In  the  same  category  of  monopoly  (control  of  a  consump- 
tion good)  we  may  place  two  other  varieties  significant  in 
the  modern  economic  world.  The  first  is  the  "corner,"  in 
which  only  a  temporary  control  is  secured,  amounting  in 
reality  to  control  over  the  time  of  marketing  of  an  existing 
stock  not  subject  to  rapid  increase  at  the  moment  by  fur- 
ther production.  The  other  is  the  use  of  trademarks,  trade 
names,  advertising  slogans,  etc.,  and  we  may  include  the 
services  of  professional  men  with  established  reputations 
(whatever  their  real  foundation).  The  buyer  being  the 
judge  of  his  own  wants,  if  the  name  makes  a  difference  to 
him  it  constitutes  a  peculiarity  in  the  commodity,  however 
similar  it  may  be  in  physical  properties  to  competing  wares. 
And  the  difference  from  physically  equivalent  goods  may  be 
very  real,  in  the  way  of  confidence  in  what  one  is  getting. 
Such  goods  are  then  commodities  whose  supply  is  controlled 
by  the  producer,  and  competition  with  other  makes  or 


186  RISK,  UNCERTAINTY,  AND  PROFIT 

brands  is  a  case  of  substitution  of  more  or  less  similar 
goods,  such  as  a  monopolist  always  has  to  take  into  ac- 
count. 

A  monopoly,  of  the  category  described,  is  evidently 
"productive"  in  the  economic  or  mechanical  causality 
sense.  It  may  be  viewed  either  as  a  separate  productive 
element,  in  which  case  it  is  property  in  perfectly  good 
business  standing,  and  may  be  exchanged  for  other  prop- 
erty on  an  income  basis.  Allowance  will  be  made  for  the 
security  of  the  income,  but  this  allowance  is  perhaps  as 
likely  to  be  in  favor  of  the  monopoly  as  against  it.  Or  we 
may  take  the  view  that  the  monopoly  of  a  consumption 
good  confers  superior  productivity  on  the  agencies  pro- 
ducing it,  above  physically  identical  agencies  in  other  uses. 
As  long  as  these  are  debarred  in  any  way  from  producing 
the  monopolized  good  the  effect  is  the  same  as  that  of  a 
physical  incapacity  to  do  so,  and  they  are,  like  the  branded 
article,  economically  differentiated,  however  similar  physi- 
cally. If  the  monopoly  is  of  the  character  of  a  patent,  and 
freely  salable  separately  from  the  plant  producing  the 
goods,  it  is  better  to  treat  it  as  a  productive  agency  on  its 
own  account. 

Again,  monopoly  may  consist  in  the  exclusive  control  of 
the  supply  of  some  productive  agency,  physically  denned  as 
a  group  of  interchangeable  units.  The  only  incentive  to 
obtain  such  a  monopoly  is  the  desire  to  secure  one  of  the 
former  type,  the  power  to  restrict  the  supply  of  some  con- 
sumption good.  The  control  of  any  type  of  productive 
agent,  of  course,  gives  control  of  the  supply  of  commodities 
whose  production  is  dependent  on  the  use  of  that  agent, 
through  the  power  to  withhold  the  agent  from  use  alto- 
gether or  restrict  its  use  in  the  making  of  any  particular 
commodity  while  leaving  its  employment  in  other  uses  free. 
Whether  the  monopolist  produces  these  goods  himself  or 
leases  his  monopolized  agency  to  others,  he  can  secure  the 
entire  increase  in  the  net  revenue  from  the  final  commodity 


PREREQUISITES  FOR  PERFECT  COMPETITION    187 

as  a  rent  on  the  restricted  and  restricting  agency.  It  is  evi- 
dent in  this  case  also  that  the  restriction  on  the  use  of  the 
agency,  whatever  its  basis,  is  equivalent  in  effect  to  a  phy- 
sical peculiarity,  and  that  the  causal  productivity  of  the 
agency  is  increased  by  its  limitation  in  the  same  way  as  if 
part  of  it  had  gone  out  of  existence  or  undergone  some  in- 
capacitating change.  Nor  should  it  be  necessary  to  insist 
again  on  the  separation  of  the  causality  aspect  of  the  case 
from  the  question  of  social  policy. 

A  somewhat  different  case  is  the  exclusive  control  of  a 
peculiarly  effective  method  or  system  of  organization  of 
production.  The  question  of  the  productivity  of  a  special 
process  protected  by  patent  or  kept  secret  is  a  difficult  one. 
Treatment  of  it  in  economic  literature  varies  from  that  of 
Lavergne,1  who  insists  that  the  idee  productrice  is  an  in- 
dependent factor,  always  present  along  with  land,  labor, 
and  capital,  to  that  of  A.  S.  Johnson,  who  contends  that  an 
idea  or  method  cannot  be  regarded  as  productive  because  it 
is  the  nature  of  an  idea  to  multiply  itself  indefinitely.2  Here, 
again,  the  crucial  test  can  only  be  the  facts  in  the  case. 
Does  the  method  or  idea  get  product  imputed  to  it?  This 
is  largely  a  question  of  whether  it  is  salable  and  so  takes  on 
capital  value.  If  so,  it  is  productive  in  the  sense  of  economic 
causality.  If  it  is  not  salable  it  will  represent  an  element 
in  the  productivity  of  its  possessor  and  its  yield  will  accrue 
to  him  in  the  form  of  a  wage.  The  moral  question,  whether 
it  "ought"  to  be  a  source  of  income,  is  of  course  another 
matter.  It  seems  evident 3  on  the  one  hand  that  the  highest 
social  advantage  would  require  the  most  rapid  and  general 
extension  of  the  use  of  the  best  methods,  and  it  is  of  signif- 
icance that  this  can  theoretically  be  done  nearly  without 

1  Bertrand  Lavergne,  ThSorie  des  marchSs  Economiques.  Paris,  1910. 

2  Rent  in  Modern  Economic  Theory,  p.  120,  note. 

8  Supposing  the  desideratum  to  be  the  greatest  possible  consumption 
of  commodities.  Supposing  it  to  be  maximum  happiness,  the  case  is  not 
so  clear,  while  the  question  of  maximum  "welfare"  involves  us  in  still 
greater  uncertainty. 


188  RISK,  UNCERTAINTY,  AND  PROFIT 

cost.  On  the  other  hand,  it  is  equally  evident  that  both 
justice  and  expediency  demand  a  fair  reward  for  the 
origination  of  better  ways  of  doing  things.  It  would  seem 
to  be  a  matter  of  political  development  to  provide  a  better 
way  of  rewarding  these  services  than  even  a  temporary 
monopoly  of  their  use;  but  this  inquiry  belongs  in  the 
theory  of  progress,  and  as  a  question  of  social  policy  is  out- 
side the  scope  of  the  present  study. 

We  must  again  insist,  however,  that  the  method  must  be 
recognized  as  being  productive,  or  as  conferring  superior 
productivity  on  the  agencies  employed  in  connection  with 
it.1  An  arbitrary  restriction  is  again  causally  equivalent  to 
physical  limitation.  The  method  or  idea  is  merely  less  pro- 
ductive of  goods  (and  more  productive  of  exchange  value) 
than  it  would  be  if  its  use  were  unrestricted.  The  same 
paradox  holds  for  any  productive  good;  if  multiplied  indefi- 
nitely it  would  yield  more  goods  in  physical  units,  but  have 
no  value  at  all.  The  only  difference  in  the  case  of  a  method 
of  production  is  that  it  can  be  multiplied  indefinitely 
without  much  cost  (after  once  worked  out),  an  important 
distinction  from  the  standpoint  of  social  policy  (perhaps), 
but  not  significant  from  the  standpoint  of  a  cause  and 
effect  explanation  of  things.  And  we  must  again  insist  that 
the  danger  of  reasoning  about  social  totals  of  exchange 
value,  and  still  more  the  extreme  treachery  of  all  reason- 
ing about  human  welfare  in  terms  of  any  such  concept  as 
economic  utility,  be  borne  in  mind  in  attempting  to  reach 
conclusions  as  to  social  policy.2 

1  There  is  a  danger  in  over-emphasizing  the  difference  between  these 
two  views  of  productivity.  Remembering  that  all  production  is  joint,  it 
is  clear  that  any  separate  productivity  of  a  particular  agency  means  ul- 
timately superior  productivity  conferred  upon  others  used  in  connection 
with  it. 

2  It  seems  in  place  to  remark  that  a  confusion  is  involved  in  laying 
down  "appropriability"  or  what  might  be  called  competitive  self- 
assertion,  as  a  condition  of  economic  productivity.  Productivity  is  a 
matter  of  limitation.  If  an  agency  is  limited  relatively  to  the  need  for  its 
use,  it  must  be  appropriated  by  some  one,  to  be  administered,  to  decide 


PREREQUISITES  FOR  PERFECT  COMPETITION    189 

The  position  taken  above,  that  monopoly  is  productive, 
is  in  opposition  to  the  doctrine  of  Professor  J.  B.  Clark  and 
his  followers  that  the  monopolist  merely  appropriates  prod- 
uct created  by  other  agents.  But  when  monopoly  income 
is  said  to  be  "diverted  from  its  real  producers,"1  or  is 
called  "exploitative,"  in  the  sense  that  it  "is  not  secured 
by  the  agent  that  creates  it,"2  the  words  "create"  and 
"produce"  are  not  used  in  their  correct  (causal)  meaning. 
Monopoly  is  impossible  except  on  the  basis  of  some  control 
over  an  element  essential  in  the  production  of  a  commodity, 
and  the  extra  product  is  rightly  imputed  to  this  essential 
element,  or  to  the  condition  which  makes  control  possible, 
if  separable  from  the  rest  of  the  situation. 

Monopoly  of  productive  agencies  has  hitherto  been  of 
restricted  importance  in  actual  affairs,  for  several  reasons. 
Most  productive  resources  are  specialized  only  to  a  limited 
extent,  and  are  subject  to  effective  competition  from  a 
wide  range  of  substitutes.  And  in  the  hitherto  undeveloped 
and  rapidly  changing  condition  of  the  world,  most  agencies, 
even  of  the  most  specialized  types,  have  been  rapidly  and 
irregularly  increasing  in  supply  through  new  discoveries, 
and  open  to  deliberate  increase  through  moderate  expend- 
itures in  exploration  and  development  work.  Finally,  the 

who  is  to  have  the  use  of  it  and  who  is  to  do  without.  And  any  productiv- 
ity conferred  on  an  object  by  appropriation  must  come  through  and  in 
connection  with  restriction  on  its  use.  Thus  Professor  Young  (Outlines 
of  Economics,  by  R.  T.  Ely  and  others,  ed.  of  1908,  pp.  555-56)  contends 
that  the  Strait  of  Gibraltar  would  be  productive  wealth  if  the  British 
Government  were  to  charge  for  its  use.  But  they  could  not  charge  for  its 
use  without  reducing  its  volume;  it  would  be  a  case  of  monopoly  merely. 
This  and  several  other  confusions  are  involved  in  Veblen's  contention 
(on  the  "Nature  of  Capital,"  Quarterly  Journal  of  Economics,  vol.  xxii, 
pp.  917  ff.,  and  vol.  xxiii,  pp.  104  ff.)  that  the  world's  stock  of  knowledge 
is  its  most  important  "capital,"  which  is  without  value  merely  because 
not  privately  exploited.  It  could  be  exploited  only  by  having  its  use  re- 
stricted; i.e.,  by  monopoly.  The  notion  that  capital  is  significant  as 
limiting  access  to  the  world  fund  of  technical  knowledge  is  absurd,  for  the 
reason,  already  noted,  that  production  is  joint,  and  the  productivity  of 
anything  may  be  viewed  as  a  productivity  conferred  on  other  things. 
1  Willett.  2  Johnson,  pp.  106.  107. 


190  RISK,  UNCERTAINTY,  AND  PROFIT 

technique  of  the  large-scale  organization  requisite  to  secure 
unified  control  has  been  crude  and  imperfect,  while  the  op- 
position of  public  opinion  has  been  increasing  in  force.  It  is 
of  some  interest  to  inquire  into  the  implications  of  abso- 
lutely free  competition  in  this  regard. 

With  perfect  intercommunication  it  would  seem  that  the 
assumed  absence  of  collusion  is  very  improbable,  as  or- 
ganization costs  would  naturally  tend  to  a  low  level.  Under 
static  conditions  (with  the  existing  stocks  of  all  agencies 
fixed  and  known),  a  great  development  of  monopoly  would 
apparently  be  inevitable.  It  is  not  unreasonable  to  suppose 
even  that  in  the  absence  of  organized  social  interference 
conditions  would  approach  the  result  contended  for  by  the 
Marxian  socialists,  monopoly  universal,  or  at  least  preva- 
lent to  an  extent  involving  the  complete  breakdown  of  the 
competitive  system  of  organization. 

A  further  consideration,  which  goes  back  to  the  require- 
ment of  negligible  size  in  the  marginal  unit  as  a  condition 
of  effective  competition,  tends  to  reinforce  this  view.  In 
the  ordinary  sense  of  monopoly,  concentration  of  control 
is  not  profitable  unless  it  is  nearly  complete.  But  with 
organization  costs  absent  or  small,  there  might  be  a  con- 
tinuous incentive  to  increase  the  size  of  the  bargaining 
unit.  It  is  true,  as  some  objectors  to  the  productivity  the- 
ory of  distribution  contend,  that  as  the  bargaining  unit  is 
larger  the  product  theoretically  dependent  upon  it  is  larger 
in  greater  ratio,  and  this  fact  affords  a  small  incentive  to 
combine  even  on  a  very  small  scale,  and  to  increase  the 
size  of  the  unit  without  limit.  The  extra  remuneration  of 
the  block  over  what  it  could  obtain  if  its  constituent  units 
bargained  separately  would  come  out  of  the  shares  of  the 
other  agents  used  in  connection  with  the  one  affected,  not 
out  of  increased  payments  extorted  from  consumers  as  in 
case  of  monopoly./ 

The  argument  may  be  shown  graphically  by  recourse  to 
the  "dosing  method"  of  explaining  specific  productivity, 


PREREQUISITES  FOR  PERFECT  COMPETITION    191 

made  familiar  by  Professor  J.  B.  Clark.  There  is  no  fallacy 
in  this  analysis  if  by  a  "factor"  of  production  we  mean 
merely  a  group  of  physically  interchangeable  things,  and 
not  a  sort  of  labor  or  capital  pulp  obtained  by  putting 
things  of  all  degrees  of  heterogeneity  through  the  mill  of 
the  competitive  process  itself  and  reducing  them  to  value 
productivity  units.  We  must  also  remember  that  the 
method  is  a  logical  device  purely,  and  in  no  sense  repre-  / 
sents  the  process  by  which  productive  services  actually  get 
evaluated.  If,  then,  we  imagine  a  static  society,  and  fix 
our  attention  upon  such  a  group  of  competing  agents,  it  will 
be  seen  that  the  different  units  or  members  composing  it 
may  be  regarded  as  placed  along  the  descending  curve  of 
diminishing  productivity  of  the  familiar  diagram.  The 
curve,  like  that  of  diminishing  utility  and  diminishing 
demand  price,1  is  purely  hypothetical ;  the  ordinate  of  each 
point  merely  shows  what  would  be  the  productivity  of  each 
unit  in  the  series  if  the  total  number  were  reduced  to  that 
indicated  by  the  corresponding  abscissa  and  production 
reorganized  along  "natural"  lines.  It  does  not  indicate 
differences  in  productivity,  or  anything  else,  at  the  moment. 
We  also  pass  over  the  fact  that  it  is  impossible  to  construct 
such  a  curve  except  for  a  very  limited  range  in  the  region  of 
known  conditions  and  that  any  considerable  extension  of  it 
(for  an  important  productive  service)  soon  carries  us  into 
the  realm  of  pure  fantasy. 

But  ignoring  the  difficulties  and  imagining  the  curve 
drawn,  it  is  obvious  that  under  theoretical  imputation  each 
member  of  any  such  group  of  competing  agents  will  get 
what  is  directly  dependent  upon  that  which  occupies  the 
least  important  position,  which  is  all  that  is  ultimately 
"dependent"  upon  any  one.  But  if  two  or  more  such 
agents  combine  so  as  to  compete  as  a  unit  instead  of  sepa- 
rately, they  can  get  the  total  product  of  that  number  of 
units  at  the  lower  end  of  the  series,  which  is  more  than 
1  Cf.  chapter  in. 


192  RISK,  UNCERTAINTY,  AND  PROFIT 

their  separate  "marginal"  products.  Therefore,  under 
perfect  competition,  they  will  combine  and  bargain  as  a 
unit;  and  the  same  incentive  will  urge  them  to  keep  on 
combining  until  a  monopoly  results. 

The  situation  is  easily  understood  from  the  conventional 
diagram.  If  the  curve  CD  represents  the  relative  importance 
of  successive  agents  of  a  series,  or  units  of  some  really  fund- 
able agent,  then  under  per- 
fect competition  every  unit 
will  get  the  product  DE, 
and  a  certain  group  E'E 
will  get  FDE'E.  If  now 
these  EE'  units  combine 
so  as  to  become  marginal 
as  a  group,  they  can  get 
instead  D'DE'E,  gaining 
D'DFover  the  former  arrangement.  The  owner  of  the  group 
can  prevent  the  substitution  of  a  (marginal)  unit  outside 
the  group  for  any  unit  in  it,  and  so  cause  a  larger  prod- 
uct to  be  dependent  on  the  employment  of  the  group  than 
the  aggregate  marginal  products  of  its  members.  Similar 
agencies  outside  the  combination  will  only  get  the  wage  DE, 
and  the  surplus  income  received  by  our  consolidated  block 
will  come  out  of  the  shares  of  the  agencies  with  which  it  is 
combined,  not  out  of  an  increase  in  the  price  of  the  prod- 
uct to  consumers.  The  employers  of  the  "block"  use  no 
more  nor  less  of  the  agency  than  before  and  make  no  more 
nor  less  product;  hence  they  must  sell  the  same  supply  at 
the  same  price.  But  the  other  agencies  are  forced  to  take 
less  for  their  services  because  the  block  cannot  be  replaced 
a  unit  at  a  time  from  the  margin,  but  only  by  an  equal 
number  of  marginal  units  at  once,  a  transfer  which  will 
raise  their  price  all  along  the  line.  Only  "friction"  (human 
limitations)  prevents  this  in  actual  society,  the  "diminish- 
ing returns  of  entrepreneurship." 

It  need  not  be  remarked  that  this  process  would  not  go 


PREREQUISITES  FOR  PERFECT  COMPETITION    193 

far  in  fact  until  something  would  have  to  be  done  to  stop 
it.  There  does  seem  to  be  a  certain  Hegelian  self-contra- 
diction in  the  idea  of  theoretically  perfect  competition  after 
all.  As  to  what  the  end  would  be,  it  is  fruitless  to  speculate, 
but  it  would  have  to  be  some  arbitrary  system  of  distribu- 
tion under  some  sort  of  social  control,  doubtless  based  on 
ethics  or  political  power  or  brute  force,  according  to  the 
circumstances  —  providing  that  society  or  somebody  in  it 
had  sufficient  intelligence  and  power  to  prevent  a  reversion 
to  the  helium  omnium  contra  omnes.  Competitive  industry 
is  or  hitherto  has  been  saved  by  the  fact  that  the  human 
individual  has  been  found  normally  incapable  of  wielding 
to  his  own  advantage  much  more  industrial  power  than, 
aided  by  legal  and  moral  restraints,  society  as  a  whole  can 
safely  permit  him  to  possess.  How  long  this  beneficent 
limitation  can  be  counted  upon  to  play  its  saving  role  may 
in  the  light  of  current  business  development  occasion  some 
doubt.  With  this  subject  we  are  not  here  particularly  con- 
cerned, but  it  has  seemed  worth  while  to  point  out,  in  con- 
nection with  the  discussion  of  an  ideal  system  of  perfect 
competition,  that  such  a  system  is  inherently  self-defeat- 
ing and  could  not  exist  in  the  real  world.  Perfect  competi- 
tion implies  conditions,  especially  as  to  the  presence  of 
human  limitations,  which  would  at  the  same  time  facilitate 
monopoly,  make  organization  through  free  contract  im- 
possible, and  force  an  authoritarian  system  upon  society.1 

1  In  addition  to  the  incentives  to  combination  afforded  by  the  gains 
through  increase  in  the  size  of  the  bargaining  unit,  another  tendency 
might  work  in  the  same  direction.  In  many  cases  it  might  be  profitable 
for  the  owner  of  a  considerable  block,  though  not  the  whole  supply  of  an 
important  productive  service,  to  restrict  its  use  and  so  increase  the  value 
of  the  product.  Whether  the  owner  of  a  part  of  a  supply  can  gain  by  with- 
holding some  of  that  part  from  use  will  depend  upon  the  fraction  of  the 
supply  which  he  holds  and  on  the  flexibility  of  the  supply  obtainable  from 
competing  sources  and  the  elasticity  of  the  demand  for  the  product.  In 
view  of  the  fact  that  practically  every  business  is  a  partial  monopoly,  it 
is  remarkable  that  the  theoretical  treatment  of  economics  has  related  so 
exclusively  to  complete  monopoly  and  perfect  competition. 

Attention  may  be  directed  to  another  tendency  fatal  to  free  competition 


194  RISK,  UNCERTAINTY,  AND  PROFIT 

In  connection  with  the  meaning  of  productivity  it  is  of 
interest  to  raise  the  question  of  the  economic  value  of  the 
State.  What  would  be  the  effect  upon  our  economic  life  if 
society  as  such,  acting  through  the  political  organization, 
should  assert  itself  as  an  economic  individual  and  charge 
"what  the  traffic  will  bear"  for  its  own  service?  Obviously 
the  Government  has  a  monopoly  on  an  absolutely  indis- 
pensable commodity.  Business  could  not  be  carried  on  at 
all  without  the  protection  of  property  and  enforcement  of 
contract.  Into  this  interesting,  but  intricate,  question  it 
is  impossible  to  enter  at  length  here,  but  it  appears  that 
what  the  Government  could  take,  its  economic  product,  is 
hardly  limited.1  The  writer  is  much  more  optimistic  as  to 
the  possibilities  of  a  drastic  program  of  taxation  for  secur- 
ing a  greater  degree  of  economic  equality  than  over  most 
proposals  for  social  interference  in  contractual  relations. 

under  theoretical  conditions.  This  is  the  matter  of  the  inflation  of  credit. 
With  all  forms  of  friction  eliminated  there  would  seem  to  be  hardly  a 
limit  to  the  substitution  of  credit  for  any  sort  of  commodity  as  a  medium  of 
exchange  and  a  stable  value-standard  would  apparently  be  impossible  to 
establish. 

1  Concerning  the  "economic  surplus"  of  which  much  has  been  made 
by  some  writers,  notably  Hobson,  the  remark  made  above  (page  188  n.) 
is  applicable.  The  payment  necessary  to  secure  the  performance  of  any 
service  depends  on  how  much  of  that  service  is  desired.  The  question  is 
much  complicated  by  human  mortality  and  the  fact  of  inheritance,  but 
in  general  there  are  no  surpluses  available  without  reducing  the  volume 
of  the  service.  This  will  not  be  true  of  monopolized  or  highly  specialized 
agencies,  and  there  are,  no  doubt,  many  remunerations  which  are  too 
high  absolutely  and  which  if  reduced  would  positively  increase  the  vol- 
ume of  the  services  for  which  they  are  paid. 


PART  III 

IMPERFECT  COMPETITION  THROUGH 
RISK  AND  UNCERTAINTY 


CHAPTER  VII 

THE  MEANING  OF  RISK  AND  UNCERTAINTY 

Starting  with  the  individual  psychology  of  valuation  and 
adding  new  factors  step  by  step,  we  have  now  built  up  a 
competitive  industrial  society  involving  valuation  and  dis- 
tribution under  the  highly  simplified  conditions  necessary 
to  perfect  competition.  The  drastic  assumptions  made 
were  necessary  to  show  the  operation  of  the  forces  at  work 
free  from  all  disturbing  influences;  and  impossible  as  the 
presuppositions  have  been,  the  principles  involved  have 
not  been  falsified  or  changed,  but  merely  exhibited  in 
purity  and  isolation.  Chief  among  the  simplifications  of 
reality  prerequisite  to  the  achievement  of  perfect  com- 
petition is,  as  has  been  emphasized  all  along,  the  assump- 
tion of  practical  omniscience  on  the  part  of  every  member 
of  the  competitive  system.  The  task  of  the  present  chapter 
is  to  inquire  more  fully  into  the  meaning  of  this  assump- 
tion. We  must  take  a  brief  excursion  into  the  field  of  the 
theory  of  knowledge  and  clarify  our  ideas  as  to  its  nature 
and  limitations,  and  the  relation  between  knowledge  and 
behavior.  On  the  basis  of  the  insight  thus  gained,  it  will 
be  possible  to  illuminate  that  large  group  of  economic 
phenomena  which  are  connected  with  the  imperfection  of 
knowledge. 

The  problem  may  be  set  in  view  and  its  significance 
made  clear  by  recalling  certain  points  already  brought  out 
in  the  previous  discussion.  In  chapter  n  it  was  pointed  ©ut 
that  the  failure  of  competition  and  the  emergence  of  profit 
are  connected  with  changes  in  economic  conditions,  but 
that  the  connection  is  indirect.  For  profit  arises  from  the 
fact  that  entrepreneurs  contract  for  productive  services  in 
advance  at  fixed  rates,  and  realize  upon  their  use  by  the  i 


'   I 


198  RISK,  UNCERTAINTY,  AND  PROFIT 

j\,  sale  of  the  product  in  the  market  after  it  is  made.  Thus 
f '  the  competition  for  productive  services  is  based  upon  an- 
ticipations. The  prices  of  the  productive  services  being 
the  costs  of  production,  changes  in  conditions  give  rise  to 
profit  by  upsetting  anticipations  and  producing  a  divergence 
between  costs  and  selling  price,  which  would  otherwise  be 
equalized  by  competition.  If  all  changes  were  to  take 
place  in  accordance  with  invariable  and  universally  known 
laws,  they  could  be  foreseen  for  an  indefinite  period  in  ad- 
vance of  their  occurrence,  and  would  not  upset  the  perfect 
apportionment  of  product  values  among  the  contributing 
agencies,  and  profit  (or  loss)  would  not  arise.  Hence  it  is 
our  imperfect  knowledge  of  the  future,  a  consequence  of 
change,  not  change  as  such,  which  is  crucial  for  the  under- 
standing of  our  problem. 

Again,  in  chapters  in  and  iv,  it  was  found  necessary  to 
assume  static  conditions  in  order  to  realize  perfect  com- 
petition. But,  as  expressly  stated,  this  assumption  was 
made  because  it  follows  from  it  as  a  corollary  that  the 
future  will  be  foreknown,  and  not  for  the  sake  of  the  prop- 
osition itself.  It  is  conceivable  that  all  changes  might  take 
place  in  accordance  with  known  laws,  and  in  fact  very 
many  changes  do  occur  with  sufficient  regularity  to  be 
practically  predictable  in  large  measure.  Hence  the  justi- 
fication and  the  necessity  for  separating  in  our  study  the 
effects  of  change  from  the  effects  of  ignorance  of  the  future. 
And  chapter  v  was  devoted  to  a  study  of  the  effects  of 
change  as  such  with  uncertainty  absent.  Here  it  was  found 
that  under  such  conditions  distribution  or  the  imputation 
of  product  values  to  production  services  will  always  be 
perfect  and  exhaustive  and  profit  absent. 

Furthermore,  as  also  argued  in  chapter  n,  it  is  unneces- 
sary to  perfect,  profitless  imputation  that  particular  occur- 
rences be  foreseeable,  if  only  all  the  alternative  possibilities 
are  known  and  the  probability  of  the  occurrence  of  each 
can  be  accurately  ascertained.  Even  though  the  business 


MEANING  of  RISK  AND  UNCERTAINTY      199 

man  could  not  know  in  advance  the  results  of  individual 
ventures,  lie  could  operate  and  base  his  competitive  offers 
upon  accurate  foreknowledge  of  the  future  if  quantitative 
knowledge  of  the  probability  of  every  possible  outcome  can 
be  had.  For  by  figuring  on  the  basis  of  a  large  number  of 
ventures  (whether  in  his  own  business  alone  or  in  that  of 
business  in  general)  the  losses  could  be  converted  into  fixed 
costs.  Such  special  costs  would,  of  course,  have  to  be  given 
full  weight,  but  they  would  be  costs  merely,  like  any  other 
necessary  outlays,  and  would  not  give  rise  to  profit,  which 
is  a  difference  between  cost  and  selling  price.  Such  situa- 
tions in  more  or  less  pure  form  are  also  common  in  every- 
day life,  and  various  devices  for  dealing  with  them  form 
an  important  phase  of  contemporary  business  organization. 
Some  of  the  more  important  of  these  devices  will  come  up      -. 
for  brief  discussion  later.    At  present  we  are  concerned   C~A 
only  to  emphasize  the  fact  that  knowledge  is  in  a  sense      V 
variable  in  degree  and  that  the  practical  problem  may      f 
relate  to  the  degree  of  knowledge  rather  than  to  its  presence      V 
or  absence  in  toto.  J 

The  facts  of  life  in  this  regard  are  in  a  superficial  sense-^ 
obtrusively  obvious  and  are  a  matter  of  common  observa- 
tion. It  is  a  world  of  change  in  which  we  live,  and  a  world 
of  uncertainty.  We  live  only  by  knowing  something  about 
the  future;  while  the  problems  of  life,  or  of  conduct  at 
least,  arise  from  the  fact  that  we  know  so  little.  This  is  as 
true  of  business  as  of  other  spheres  of  activity.  The  es- 
sence of  the  situation  is  action  according  to  opinion,  of 
greater  or  less  foundation  and  value,  neither  entire  ig- 
norance nor  complete  and  perfect  information,  but  partial 
knowledge.  If  we  are  to  understand  the  workings  of  the 
economic  system  we  must  examine  the  meaning  and  sig- 
nificance of  uncertainty;  and  to  this  end  some  inquiry  into 
the  nature  and  function  of  knowledge  itself  is  necessary.1 

1  The  problem  of  uncertainty  and  risk  in  economics  is,  of  course,  not 
new.   Some  reference  has  already  been  made  to  the  literature.   It  has 


200  RISK,  UNCERTAINTY,  AND  PROFIT 

The  first  datum  for  the  study  of  knowledge  and  behavior 
is  the  fact  of  consciousness  itself.  Apparently  the  higher 
mental  operations  of  reason  are  different  only  in  degree, 
only  elaborations  of  what  is  inherent  in  the  first  spark  of 
"awareness."  The  essence  of  mentality  from  a  functional 
standpoint  seems  to  be  its  forward-looking  character.  Life 
has  been  described  as  internal  adaptations  to  external 
coexistences  and  sequences.  On  the  vegetable  or  uncon- 
scious plane,  the  internal  changes  are  simultaneous  with 
the  external.  The  fundamental  difference  in  the  case  of 
animal  or  conscious  life  is  that  it  can  re  Act  to  a  situation 
before  that  situation  materializes;  it  can  "see  things  com- 
ing." This  is  what  the  whole  complicated  mechanism  of 
the  nervous  system  is  "for,"  in  the  biological  sense.  The 
readjustments  by  which  the  organism  adapts  itself  to  the 
environment  require  time,  and  the  farther  ahead  the  or- 
ganism can  "see,"  the  more  adequately  it  can  adapt  itself, 
the  more  fully  and  competently  it  can  live. 

been  recognized  and  discussed  in  three  connections:  (1)  insurance;  (2) 
speculation;  and  (3)  entrepreneurship.  For  a  full  treatment  of  the  last- 
named  it  is  necessary  to  go  to  the  German  works  cited  in  the  historical 
portion  of  this  study.  English  economics  has  been  too  exclusively  oc- 
cupied with  long-time  tendencies  or  with  "static"  economics  to  give 
adequate  attention  to  this  problem.  For  a  very  general  discussion  of  un- 
certainty see,  in  addition  to  works  already  cited,  Ross,  Uncertainty  as  a 
Factor  in  Production,  Annals,  American  Academy,  vol.  viii,  pp.  304  ff. 
See  also  Leslie,  T.  E.  Cliffe,  "The  Known  and  the  Unknown  in  the 
Economic  World,"  Essays  in  Political  Economy,  pp.  221-42;  Lavington, 
F.,  "Uncertainty  in  its  Relation  to  the  Rate  of  Interest,"  in  Economic 
Journal,  vol.  xxn,  pp.  398-409;  and  "The  Social  Interest  in  Speculation," 
ibid.,  vol.  xxiii,  pp.  36-52;  Pigou,  A.  C,  Wealth  and  Welfare,  part  v; 
Haynes,  John,  "Risk  as  an  Economic  Factor,"  Quarterly  Journal  of 
Economics,  July,  1895. 

In  this  superficial  sketch  of  the  theory  of  knowledge  it  has  not  seemed 
important  to  give  extended  reference  to  philosophic  literature.  It  will  be 
evident  that  the  doctrine  expounded  is  a  functional  or  pragmatic  view, 
with  some  reservations.  By  way  of  further  "reservation"  we  should 
point  out  that  the  tone  of  the  discussion  merely  results  from  the  fact 
that  it  is  the  function  of  consciousness  and  knowledge  in  relation  to  con- 
duct that  we  are  interested  in,  for  present  purposes,  and  the  text  must  not 
be  taken  as  expressing  any  view  whatever  as  to  the  ultimate  nature  of 


MEANING  OF  RISK  AND  UNCERTAINTY      201 

Just  what  consciousness  as  such  has  to  do  with  it  is  a 
mystery  which  will  doubtless  remain  inscrutable.1  It  is  a 
mere  brute  fact  that  wherever  we  find  complicated  adapta- 
tions we  find  consciousness,  or  at  least  are  compelled  to 
infer  it.  Science  can  find  no  place  for  it,  and  no  role  for  it 
to  perform  in  the  causal  sequence.  It  is  epiphenomenal.  An 
explanation  of  the  readjustment  necessarily  runs  in  terms  of 
stimulus  and  reaction,  in  this  temporal  order.  Yet  in  our 
own  experience  we  know  that  we  do  not  react  to  the  past 
stimulus,  but  to  the  "image"  of  a  future  state  of  affairs; 
and  for  common  sense,  consciousness,  the  "image,"  is  both 
present  and  operative  wherever  adaptations  are  dissociated 
from  any  immediate  stimulus;  i.e.,  are  "spontaneous"  and 
forward-looking.  It  is  evident  that  all  organic  reactions 
relate  to  future  situations,  farther  in  the  future  as  the  type 
of  life  and  activity  is  "higher."  However  successful  mech- 
anistic science  may  be  in  explaining  the  reaction  in  terms 
of  a  past  cause,  it  will  still  be  irresistibly  convenient  for 
common  sense  to  think  of  it  as  prompted  by  a  future  situa- 
tion present  to  consciousness.  The  role  of  consciousness  is 
to  give  the  organism  this  "knowledge"  of  the  future.  For 
all  we  can  see  or  for  all  that  science  can  ever  tell  us,  we 
might  just  as  well  have  been  unconscious  automata,  but 
we  are  not.  At  least  the  person  speaking  is  not,  and  he 
cannot  help  attributing  to  other  creatures  similarly  con- 
stituted and  behaving  in  the  same  way  with  himself  "in- 
sides,"  to  use  Descartes'  picturesque  term,  like  his  own. 
We  perceive  the  world  before  we  react  to  it,  and  we  react 
not  to  what  we  perceive,  but  always  to  what  we  infer. 

The  universal  form  of  conscious  behavior  is  thus  action 
designed  to  change  a  future  situation   inferred  from  a 

reality  or  any  other  philosophic  position.  The  writer  is  in  fact  a  radical 
empiricist  in  logic,  which  is  to  say,  as  far  as  theoretical  reasoning  is  con- 
cerned, an  agnostic  on  all  questions  beyond  the  fairly  immediate  facts  of 
experience. 

1  See  the  brilliant  lectures  of  E.  DuBois-Raymond,  "  Uber  die  Grenzen 
des  Naturerkennens"  and  "Die  sieben  Weltratsel." 


202  RISK,  UNCERTAINTY,  AND  PROFIT 

present  one.  It  involves  perception  and,  in  addition, 
twofold  inference.  We  must  infer  what  the  future  situation 
would  have  been  without  our  interference,  and  what  change 
will  be  wrought  in  it  by  our  action.  Fortunately  or  unfor- 
tunately, none  of  these  processes  is  infallible,  or  indeed 
ever  accurate  and  complete.  We  do  not  perceive  the  pres- 
ent as  it  is  and  in  its  totality,  nor  do  we  infer  the  future 
from  the  present  with  any  high  degree  of  dependability, 
nor  yet  do  we  accurately  know  the  consequences  of  our  own 
actions.  In  addition,  there  is  a  fourth  source  of  error  to 
be  taken  into  account,  for  we  do  not  execute  actions  in 
the  precise  form  in  which  they  are  imaged  and  willed. 
The  presence  of  error  in  these  processes  is  perhaps  a  phase 
of  the  fundamental  mystery  of  the  processes  themselves.  It 
seems  to  be  an  earnest  of  their  non-mechanical  character, 
for  machines,  generally  speaking,  do  not  make  mistakes. 
(Though  it  may  not  be  legitimate  to  draw  inferences  from 
the  crude  machines  of  our  own  construction  to  the  infinitely 
more  sensitive  and  intricate  physico-chemical  complexes 
which  make  up  organic  systems.)  In  any  case  the  fact  of 
liability  to  err  is  painfully  familiar  and  is  all  that  concerns 
us  here.  It  is  interesting  to  note  that  the  perceptive 
faculties  seem  often  to  be  less  acute  and  dependable  in  the 
higher  forms  of  life  than  in  some  of  the  lower.  At  least 
civilized  man  is  often  weak  in  this  respect  in  comparison 
with  primitive  man  and  the  higher  animals.  Higher  powers 
of  inference  may  take  the  place  of  perceptive  faculties  to  a 
large  extent,  and  we  have  undoubtedly  developed  reasoning 
power  and  lost  ground  with  respect  to  keenness  of  sense. 

It  must  be  recognized  further  that  no  sharp  distinction 
can  be  drawn  between  perception  and  reason.  Our  per- 
ceptive faculties  are  highly  educated  and  sophisticated, 
and  what  is  present  to  consciousness  in  the  simplest  situa- 
tion is  more  the  product  of  inference,  more  an  imaginative 
construct  than  a  direct  communication  from  the  nerve 
terminal  organs.  A  rational  animal  differs  from  a  merely 


MEANING  OF  RISK  AND  UNCERTAINTY      203 

conscious  one  in  degree  only;  it  is  more  conscious.  It  is  im- 
material whether  we  say  that  it  infers  more  or  perceives 
more.  Scientifically  we  can  analyze  the  mental  content  into 
sense  data  and  imagination  data,  but  the  difference  hardly 
exists  for  consciousness  itself,  at  least  in  its  practical  as- 
pects. Even  in  "thought"  in  the  narrow  sense,  when  the 
object  of  reflection  is  not  present  to  sense  at  all,  the  expe- 
rience itself  is  substantially  the  same.  The  function  of  con- 
sciousness is  to  infer,  and  all  consciousness  is  largely  in- 
ferential, rational.  By  which,  again,  we  mean  that  things 
not  present  to  sense  are  operative  in  directing  behavior,  that 
reason,  and  all  consciousness,  is  forward-looking;  and  an 
essential  element  in  the  phenomena  is  its  lack  of  automatic 
mechanical  accuracy,  its  liability  to  error. 

The  statement  that  a  situation  not  in  physical  relations 
with  an  organism,  not  even  in  existence,  influences  that 
organism,  is  of  course  in  a  sense  figurative;  the  influence 
is  indirect,  operating  through  a  situation  with  which  the 
organism  is  in  contact  at  the  moment.  Hence,  as  already 
pointed  out,  it  is  always  theoretically  possible  to  ignore  the 
form  of  the  conscious  relation,  and  interpret  the  reaction 
as  a  mechanical  effect  of  the  cause  actually  present.  But 
it  remains  true  that  practically  we  must  regard  the  situa- 
tion present  to  consciousness,  not  the  one  physically 
present,  as  the  controlling  cause.  In  spite  of  rash  state- 
ments by  over-ardent  devotees  of  the  new  science  of  "be- 
havior," it  is  preposterous  to  suppose  that  it  will  ever 
supersede  psychology  (which  is  something  very  different) 
or  the  theory  of  knowledge,  in  something  like  their  historic 
for  £s. 

It  is  evident  that  the  possibility  of  a  situation  not  pres- 
ent, operating  through  one  which  is  present,  is  conditioned 
upon  some  sort  of  dependable  relation  between  the  two. 
This  postulate  of  all  knowledge  and  thought  has  been 
variously  formulated  as  the  "law"  or  "principle"  of  "cau- 
sality," and  "uniformity"  or  "regularity"  of  nature,  etc. 


204  RISK,  UNCERTAINTY,  AND  PROFIT 

Remembering  that  we  are  speaking  of  the  surface  facts, 
not  metaphysical  interpretations,  we  may  say  that  all 
reasoning  rests  on  the  principle  of  analogy.  We  know  the 
absent  from  the  present,  the  future  from  the  now,  by  as- 
suming that  connections  or  associations  among  phenom- 
ena which  have  been  valid  will  be  so;  we  judge  the  future 
by  the  past.  Experience  has  taught  us  that  certain  time 
and  space  relations  subsist  among  phenomena  in  a  degree 
to  be  depended  upon.  This  dogma  of  uniformity  of  coex- 
istence and  sequence  among  phenomena  is  a  fairly  satis- 
factory statement  of  the  postulate  of  thought  and  forward- 
looking  action  from  the  standpoint  of  the  philosopher. 
But  from  the  more  superficial  standpoint  of  common 
sense  (and  hence  of  an  inquiry  such  as  the  present)  the 
term  "phenomenon"  is  rather  vague  and  elusive,  and  a 
more  serviceable  formulation  seems  possible.  Common 
sense  works  in  terms  of  a  world  of  objects  or  merely 
"things."  Consequently  the  idea  of  things  manifesting 
constant  modes  of  behavior  seems  to  be  a  better  "category" 
than  that  of  uniformity  of  relation  among  phenomena. 
This  may  be  unsatisfactory  to  the  philosopher,  who  will 
protest  at  once  that  the  thing  is  merely  a  sum  of  its  modes 
of  behavior,  that  no  such  separation  is  really  possible.  It  is 
the  ancient  riddle  which  so  puzzled  Locke,  of  the  attribute 
and  substratum,  the  substratum,  of  course,  tending  to 
evaporate  under  critical  scrutiny.  But  this  weakness  may 
prove  rather  a  source  of  strength  for  the  use  which  we  in- 
tend to  make  of  the  notion,  as  will  be  argued. 

We  have,  then,  our  dogma  which  is  the  presupposition 
of  knowledge,  in  this  form;  that  the  world  is  made  up  of 
things,  which,  under  the  same  circumstances,  always  behave 
in  the  same  way.  The  practical  problem  of  inference  or  pre- 
diction in  any  particular  situation  centers  around  the  first 
two  of  these  three  factors :  what  things  are  we  dealing  with, 
and  what  are  the  circumstances  which  condition  their  ac- 
tion? From  knowledge  of  these  two  sets  of  facts  it  must  be 


MEANING  OF  RISK  AND  UNCERTAINTY      205 

possible  to  say  what  behavior  is  to  be  expected.  The  chief 
logical  problem,  as  already  noticed,  lies  in  the  conception 
of  a  "thing."  For  it  is  obvious  that  the  "circumstances" 
which  condition  the  behavior  of  any  particular  thing  are 
composed  of  other  things  and  their  behavior.  The  as- 
sumption that  under  the  same  circumstances  the  same 
things  behave  in  the  same  ways  thus  raises  the  single  ques- 
tion of  how  far  and  in  what  sense  the  universe  is  really 
made  up  of  such  "things"  which  preserve  an  unvarying 
identity  (mode  of  behavior).  It  is  manifest  that  the  or- 
dinary objects  of  experience  do  not  fit  this  description 
closely,  certainly  not  such  "things"  as  men  and  animals 
and  probably  not  even  rocks  and  planets  in  the  strict 
sense.  Science  has  rested  upon  the  further  assumption  that 
this  superficial  divergence  of  fact  from  theory  arises  be- 
cause the  "things"  of  everyday  experience  are  not  the 
"ultimate"  things,  but  are  complexes  of  things  which  really 
are  unchanging.  And  the  progress  of  science  has  consisted 
mostly  in  analyzing  variable  complexes  into  unvarying 
constituents,  until  now  we  have  with  us  the  electron. 

But  workable  knowledge  of  the  world  requires  much  more 
than  the  assumption  that  the  world  is  made  up  of  units 
which  maintain  an  unvarying  identity  in  time.  There  are 
far  too  many  objects  to  be  dealt  with  by  a  finite  intelli- 
gence, however  unvarying  they  might  be,  if  they  were  all 
different.  We  require  the  further  dogma  of  identical  sim- 
ilarity between  large  numbers  of  things.  It  must  be  pos- 
sible not  merely  to  assume  that  the  same  thing  will  always 
behave  in  the  same  way,  but  that  the  same  kind  of  thing 
will  do  the  same,  and  that  there  is  in  fact  a  finite,  practi- 
cally manageable  number  of  kinds  of  things.  Hence  the 
fundamental  role  which  classification  has  always  played  in 
thought  and  the  theory  of  thought.  For  our  limited  in- 
telligence to  deal  with  the  world,  it  must  be  possible  to 
infer  from  a  perceived  similarity  in  the  behavior  of  objects 
to  a  similarity  in  respects  not  open  to  immediate  observa- 


206  RISK,  UNCERTAINTY,  AND  PROFIT 

tion.  That  is,  we  must  assume  that  the  properties  of  things 
are  not  shuffled  and  combined  at  random  in  nature,  but 
that  the  number  of  groupings  is  limited  or  that  there  is 
constancy  of  association.  This  is  the  dogma  of  the  "reality 
of  classes,"  familiar  to  students  of  logic. 

But  even  this  is  not  enough.  If  the  classification  of  ob- 
jects be  restricted  to  the  grouping  of  things  in  all  respects 
similar  or  substantially  identical,  there  would  still  be  a 
quite  impossible  number  of  kinds  of  things  for  intelligence 
to  grasp.  Even  in  the  sense  of  practical  degrees  of  com- 
pleteness of  similarity,  identity  to  ordinary  observation, 
our  groups  would  be  far  too  small  and  too  numerous.  It  is 
questionable  whether  classification  would  be  carried  far 
enough  on  this  basis  to  be  of  substantial  assistance  in  sim- 
plifying our  problems  to  the  point  of  manageability.  It  is 
not  that  kind  of  a  world.  And  even  abstracting  from  mere 
differences  in  degree  such  as  size  and  the  like,  for  which 
intelligence  readily  makes  allowance,  the  same  would  still 
hold  true.  It  is  clear  that  to  live  intelligently  in  our  world, 
—  that  is,  to  adapt  our  conduct  to  future  facts,  —  we  must 
use  the  principle  that  things  similar  in  some  respects  will 
behave  similarly  in  certain  other  respects  even  when  they 
are  very  different  in  still  other  respects.  We  cannot  make 
an  exhaustive  classification  of  things,  but  must  take  various 
and  shifting  groupings  according  to  the  purpose  or  prob- 
lem in  view,  assimilating  things  now  on  the  basis  of  one 
common  property  (mode  of  behavior)  and  now  on  the  basis 
of  another.  The  working  assumption  of  practical  inference 
about  the  environment  is  thus  a  working  number  of  prop- 
erties or  modes  of  resemblance  between  things,  not  a  work- 
able number  of  kinds  of  things;  this  latter  we  do  not 
have.  That  is,  the  properties  of  things  which  influence 
our  reactions  toward  them  must  be  sufficiently  limited  in 
number  and  in  modes  of  association  for  intelligence  to 
grasp. 

We  may  sum  up  these  facts  about  the  environment  of 


MEANING  OF  RISK  AND  UNCERTAINTY      207 

our  lives  which  are  fundamental  for  conduct  in  the  follow- 
ing propositions : 

1.  The  world  is  made  up  of  objects  which  are  practically\ 
infinite  in  variety  as  aggregates  of  sensible  qualities  ) 
and  modes  of  behavior  not  immediately  sensible.  / 
And  when  we  consider  the  number  of  objects  which/ 
function  in  any  particular  conduct  situation,  and  / 
their  possible  variety,  it  is  evident  that  only  an  ffi-( 
finite  intelligence  could  grasp  all  the  possible~com- 
binations. 
£7  Finite  intelligence  is  able  to  deal  with  the  world  be- 
cause  y/ 

a.  The  number  of  distinguishable  properties  and 
modes  of  behavior  is  limited,  the  infinite  variety 
in  nature  being  due  to  different  combinations  of 
the  attributes  in  objects. 

b.  Because  the  properties  of  things  remain  fairly 
constant;  and 

c.  Such  changes  in  them  as  take  place  occur  in 
fairly  constant  and  ascertainable  ways. 

d.  The  non-sensible  properties  and  modes  of  be- 
havior of  things  are  associated  with  sensible 
properties  in  at  least  fairly  uniform  ways. 

It  is  to  be  noted  under  (a)  that  differences  in  kind  are 
referred  to  rather  than  differences  in  degree,  and  we  should 
add  that 

3.  The  quantitative  aspect  of  things  and  the  power  of 
intelligence  to  deal  with  quantity  is  a  fundamental 
element  in  the  situation. 

4.  It  is  also  fundamental  that  in  regard  to  certain  proper- 
ties objects  differ  only  in  degree,  that  mass  and  spacial 
magnitude  axe  universal  qualities  of  things,  which  do 
not  exhibit  differences  in  kind. 

5.  Following  out  the  same  principle  of  (4)  many  of  the 
most  significant  properties  are  common  \p  vpry  largp 
groups;  in  respect  to  the  qualities  most  important  for 


208  RISK,  UNCERTAINTY,  AND  PROFIT 

conduct,  there  are  a  very  few  kinds.  The  intelligi- 
bility  of  the  world  is  enormously  increased  if  not 
actually  made  possible  by  the_simplicity  of  the  great 
divisions  into  solid,  liquid,  and..ga,S  intf>  living  and 
not-living  things,  and  the  like.  And  there  is  a  hier- 
archy of  attributes  l  in  order  of  generahty_down  J;o^ 
the  slight  peculiarities  which  probably  distinguish 
in  some  mariner  "and  degree  (other  than  mere  situa- 
tion) every  nameable  thing  in  the  universe  from  every 
other,  giving  it  individuality. 

6.  The  postulates  of  intelligent  behavior  would  be  very 
incomplete  without  formal  insistence  on  the  role 
played  by  the  fact  of  consciousness  inj;*  objects  "  out- 
side ourselves,  human  beings  and  animals.  The  be- 
haviorist  notwithstanding,  the  inferences  as  to  the 
behavior  to  be  anticipated  which  we  draw  from  the 
configuration  of  the  lines  about  the  mouth,  the  gleam 
or  "twinkle"  of  an  eye  or  a  shrill  or  "soft"  vocal 
sound,  are  not  made  from  these  physical  features  as 
such  or  alone,  but  through  "sympathetic  introspec- 
tion" 2  into  what  is  going  on  in  the  "mind"  of  the 
"object"  contemplated,  and  would  be  impossible 
without  this  mysterious  capacity  of  interpretation. 
It  is  always  possible  for  the  scientist  to  argue  the  con- 
trary, as  it  is  for  him  to  demonstrate  that  we  are  not 
really  conscious  ourselves,  but  common  sense  properly 
revolts  against  the  one  conclusion  as  against  the 
other. 

7.  It  goes  without  saying  that  we  must  know  ourselves 
as  well  as  the  world.  Hence  we  must  list  our  sense  of 
our  own  powers  of  movement,  etc. 

It  is  perhaps  superfluous  to  speak  here  of  the  syllogism 
and  its  place  in  logical  theory.   Empirical  logicians  such 

1  Cf.  Comte's  Classification  of  the  Sciences. 

2  Professor   Cooley's  descriptive  phrase.    See   Social  Organization, 
chap.  i. 


MEANING  OF  RISK  AND  UNCERTAINTY      209 

as  Mill  and  Venn  have  ventilated  the  subject  sufficiently 
and  shown  that  no  real  inference  is  involved  in  the  syllo- 
gisnritself,  that  the  inference  takes  place  in  the  formula- 
tion of  the  premises  and  consists  in  the  recognition  of  a 
constant  factual  connection  between  the  predicates  de- 
noted by  the  different  terms. 

We  are  rather  concerned  here  with  pointing  out  that  the 
theory  of  knowledge  as  it  is  worked  out  by  logicians  is 
primarily  a  theory  of  exact  knowledge,  of  rigorous  demon- 
stration. It  has  become  somewhat  the  fashion,  especially 
since  Bergson  came  into  vogue,  to  be  iirationalistic,  and 
question  the  validity  of  logical  processes.  It  seems  to  the 
writer  that  there  is  much  ground  for  this  position,  but  that 
its  implications  are  very  liable  to  be  misunderstood.  There 
is  to  my  mind  no  question  of  understanding  the  world  by 
any  other  method.  There  is,  however,  much  question  as  to 
how  far  the  world  is  intelligible  at  all.  This  will  be  seen 
to  be  a  question  of  the  facts  as  to  the  uniformity  of  be- 
havior of  natural  objects  and  the  similarities  subsisting  be- 
tween them,  on  the  ground  of  which  inference  is  made  from 
one  to  another.  In  so  far  as  there  is  "real  change"  in  the 
Bergsonian  (i.e.,  Heracleitean)  sense  it  seems  clear  that 
reasoning  is  impossible.  In  addition  we  have  to  make  the 
still  more  questionable  assumption  that  the  situation  ele- 
ments or  fundamental  kinds  of  object  properties  upon 
which  we  fall  back  for  simplicity  (practically  finitude)  in 
view  of  the  unmanageable  number  of  kinds  of  objects  as 
wholes,  are  unvarying  from  one  "combination"  (i.e.,  one 
object)  to  another.  This  assumption  is  doubtless  valid  in 
some  connections.  Thus  weight,  inertia,  etc.,  are  undoubt- 
edly the  same  in  a  living  as  in  a  non-living  object.  But 
that  the  quality  "living"  is  really  the  same  in  any  two 
kinds  of  living  things  is  more  open  to  doubt.  In  so  far  as 
these  general  attributes  are  not  uniform  and  cannot  be 
given  a  definite  meaning  which  is  the  same  for  all  the  ob- 
jects in  the  class  which  they  designate,  reasoning  from  one 


210  RISK,  UNCERTAINTY,  AND  PROFIT 

member  of  the  class  to  another  is  clearly  invalid.  That  is, 
valid  classification  assumes  identity  in  some  respect.  It  is 
not  absolutely  certain  that  the  ground  on  which  we  as- 
cribe similarity  to  things  and  class  them  together  and  rea- 
son from  the  behavior  of  one  to  that  of  the  other  is  always 
of  this  character.  The  power  of  one  thing  to  suggest  an- 
other is  often  quite  mysterious,  and  may  possibly  not  rest 
upon  the  possession  of  any  common  real  qualities  which 
will  support  a  valid  inference.1 

The  practical  limitation  of  knowledge,  however,  rests 
upon  very  different  grounds.  The  universe  may  not  be 
ultimately  knowable  (we  speak,  of  course,  only  of  objective 
phenomena,  of  behavior,  not  of  problems  which  transcend 
ordinary  experience  of  fact) ;  but  it  is  certainly  knowable  to 
a  degree  so  far  beyond  our  actual  powers  of  dealing  with  it 
through  knowledge  that  any  limitations  of  knowledge  due 
to  lack  of  real  consistency  in  the  cosmos  may  be  ignored. 
It  probably  occasions  surprise  to  most  persons  the  first 
time  they  consider  seriously  what  a  small  portion  of  our 
conduct  makes  any  pretense  to  a  foundation  in  accurate 
and  exhaustive  knowledge  of  the  things  we  are  dealing 
with. 

It  is  only  when  our  interest  is  restricted  to  a  very  nar- 
row aspect  of  the  behavior  of  an  object,  dependent  upon 
its  physical  attributes  of  size,  mass,  strength,  elasticity,  or 
the  like,  that  exact  determination  is  theoretically  possible; 
and  only  by  refined  laboratory  technique  that  the  deter- 
mination can  be  actually  made.  The  ordinary  decisions  of 
life  are  made  on  tlie  ba,si«  of  "^tfimntn"  nf  a  midft  nnd 
superficial  character.  In  general  the  future  situation  in 
relation  to  which  we  act  depends  upon  the  behavior  of 
an  indefinitely  large  number  of  objects,  and  is  influenced 
by  so  many  factors  that  no  real  effort  is  made  to  take  ac- 
count of  them  all,  much  less  estimate  and  summate  their 
separate  significances.  It  is  only  in  very  special  and  crucial 

1  See  James,  Psychology,  chap,  xxii,  on  "Association  by  Similarity." 


MEANING  OF  RISK  AND  UNCERTAINTY       211 

cases  that  anything  like  a  mathematical  (exhaustive  and 
quantitative)  study  can  be  made. 

The  mental  operations  by  which  ordinary  practical  de- 
cisions are  made  are  very  obscure,  and  it  is  a  matter  for 
surprise  that  neither  logicians  nor  psychologists  have 
shown  much  interest  in  them.  Perhaps  (the  writer  is  in- 
clined to  this  view)  it  is  because  there  is  really  very  little 
to  say  about  the  subject.  Prophecy  seems  to  be  a  good 
deal  like  memory  itself,  on  which  it  is  based.  When  we  wish 
to  think  of  some  man's  name,  or  recall  a  quotation  which 
has  slipped  our  memory,  we  go  to  work  to  do  it,  and  the 
desired  idea  comes  to  mind,  often  when  we  are  thinking 
about  something  else  —  or  else  it  does  not  come,  but  in 
either  case  there  is  very  little  that  we  can  tell  about  the 
operation,  very  little  "technique."  So  when  we  try  to  de- 
cide what  to  expect  in  a  certain  situation,  and  how  to  be- 
have ourselves  accordingly,  we  are  likely  to  do  a  lot  of  ir- 
relevant mental  rambling,  and  the  first  thing  we  know  we 
find  that  we  have  made  up  our  minds,  that  our  course  of 
action  is  settled.  There  seems  to  be  very  little  meaning  in 
what  has  gone  on  in  our  minds,  and  certainly  little  kinship 
with  the  formal  processes  of  logic  which  the  scientist  uses 
in  an  investigation.  We  contrast  the  two  processes  by  rec- 
ognizing that  the  former  is  not  reasoned  knowledge,  but 
"judgment,"  "common  sense,"  or  "intuition."  There  is 
doubtless  some  analysis  of  a  crude  type  involved,  but  in 
the  main  it  seems  that  we  "infer"  largely  from  our  expe- 
rience of  the  past  as  a  whole,  somewhat  in  the  same  way 
that  we  deal  with  intrinsically  simple  (unanalyzable)  prob- 
lems like  estimating  distances,  weights,  or  other  physical 
magnitudes,  when  measuring  instruments  are  not  at  hand.1 

The  foregoing  discussion  of  reasoning  relates  to  ideal  or 
complete  inference  based  on  uniformity  of  association  of 
predicates  and  which  can  be  formulated  in  universal  propo- 

1  Marshall  remarks  that  the  business  manager's  decisions  are  guided  by 
"trained  instinct"  rather  than  knowledge.  (Principles,  6th  ed.,  p.  406.) 


212  RISK,  UNCERTAINTY,  AND  PROFIT 

sitions.  The  theory  of  formal  deductive  logic  has,  of 
course,  always  recognized  also  reasoning  from  what  are 
undescriptively  called  "particular"  propositions  —  "occa- 
sional "  would  be  a  better  term  —  asserting  that  two  pred- 
icates sometimes  belong  to  the  same  subject,  or  that  two 
classes  of  objects  overlap.  The  goal  of  science  is  always  to 
get  rid  of  this  form  of  assertion,  to  "explain"  the  occur- 
rence and  non-occurrence  of  the  quality  by  finding  some 
other  general  fact  in  the  past  history  of  the  object  with 
which  the  association  is  universal.  But  there  are  large 
classes  of  cases  in  which  this  cannot  be  done  even  scientifi- 
cally, and  the  rough  operations  of  everyday  unscientific 
thinking  employ  the  form*  quite  commonly.  In  the  crude 
form  of  "some  X  is  F,"  such  generalizations  are  very  un- 
satisfactory to  the  scientific  mind  and  practically  useless 
except  as  a  challenge  and  starting-point  for  further  inquiry. 
But  when,  as  is  so  commonly  the  case,  it  is  impossible  or 
impracticable  to  do  better,  the  data  can  often  be  put  in  a 
form  of  a  great  deal  of  scientific  utility.  This  is  done  by 
ascertaining  the  numerical  proportion  of  the  cases  in  which 
X  is  associated  with  F,  which  yields  the  familiar  probability 
judgment.  If,  say,  ninety  per  cent  of  X  is  F,  —  i.e.,  if 
that  fraction  of  objects  characterized  by  property  X  shows 
also  property  F,  —  the  fact  may  obviously  have  much  the 
same  significance  for  conduct  as  if  the  association  were 
universal.1 

Furthermore,  even  if  the  proportion  is  not  approximately 
one  hundred  per  cent,  even  if  it  is  only  half  or  less,  the 
same  fact  may  hold  good.   If,  in  a  certain  class  of  cases  a 

1  When  variations  in  degree  in  the  attributes  X  and  Y  are  taken  into 
account,  the  problem  must  be  dealt  with  by  applying  the  statistical  theory 
of  correlation,  which  is  a  further  development  of  probability  theory. 
See  especially  the  works  of  K.  Pearson  and  F.  Y.  Edgeworth.  An  ele- 
mentary discussion  will  be  found  in  any  treatise  on  statistics.  A.  L. 
Bowley's  Measurement  of  Groups  and  Series  is  particularly  serviceable 
for  the  general  reader.  A  rough  idea  may  be  obtained  from  Elderton's 
Primer  of  Statistics.  Pearson's  Grammar  of  Science,  chaps,  iv  and  v,  may 
be  consulted  on  the  whole  ground  of  the  present  chapter. 


MEANING  OF  RISK  AND  UNCERTAINTY      213 

given  outcome  is  not  certain,  nor  even  extremely  probable, 
but  only  eontingent.  hnt  if  the  nqmeriWI  prpjfrflhilit.y  of  its 
occurrence  is  known,  conduct  in  relation  to  the  situation  in 
question  may  be  ordered  intelligently.  Business  operations, 
as  already  observed,  illustrate  the  point  perfectly.  Thus,  in 
the  example  given  by  von  Mangoldt,  the  bursting  of  bot- 
tles does  not  .introduce  an  uncertainty  or  hazard  into  the 
^Business  of  producing  champagne;  since  in  the  operations 
of  any  producer  a  practically  constant  and  known  propor- 
tion of  the  bottles  burst,  it  does  not  especially  matter  even 
whetheMhe  proportion  is  large  or  small.  The  loss  becomes 
a  fixed  cost  in  the  industry  and  is  passed  on  to  the  con- 
sumer, like  the  outlays  for  labor  or  materials  or  any  other. 
And  even  if  a  single  producer  does  not  deal  with  a  suffi- 
ciently large  number  of  cases  of  the  contingency  in  ques- 
tion (in  a  sufficiently  short  period  of  time)  to  secure  con- 
stancy in  its  effects,  the  same  result  may  easily  be  realized, 
through  an  organization  taking  in  a  large  number  of  pro- 
ducers. This,  of  course,  is  the  principle  of  insurance,  as 
familiarly  illustrated  by  the  chance  of  fire  loss.  No  one  can 
say  whether  a  particular  building  will  burn,  and  most  build- 
ing owners  do  not  operate  on  a  sufficient  scale  to  reduce  the 
loss  to  constancy  (though  some  do) .  But  as  is  well  known,  the 
effect  of  insurance  is  to  extend  this  base  to  cover  the  opera- 
tions of  a  large  number  of  persons  and  convert,  the  eonttin- 
jjency  mto  a  fixed  cost.  It  makes  no  difference  in  the  prin- 
ciples whether  the  grouping  of  eases  is  effected  through  a 
mutual  organization  of  the  persons  directly  aitected  or 
through  an  outside  commercial  agency. 

It  will  be  evident  that  the  practical  difficulties  of  order- 
ing conduct  intelligently  are  enormously  increased  where 
the  inference  is  contingent  instead  of  being  positive.  The 
difficulties  of  establishing  an  association  between  predicates 
are  great  enough  where  the  association  is  universal;  so 
great,  as  we  have  already  seen,  that  it  is  never  done  with 
any  approach  to  accuracy  except  for  critical  cases  of  very 


214  RISK,  UNCERTAINTY,  AND  PROFIT 

special  importance  justifying  extensive  study  in  laboratory 
or  "field."  Where  the  connection  is  occasional,  demonstra- 
tion of  a  dependable  connection  is  vastly  more  difficult, 
and  there  is  the  added  problem  of  ascertaining  the  precise 
proportion  of  cases  in  which  the  connection  occurs.  In  re- 
lation to  everyday  problems,  where  rigorous  scientific 
procedure  is  excluded,  the  difficulty  and  chance  of  error  are, 
of  course,  multiplied  in  still  greater  degree  I  We  have  to 
"estimate"  not  merely  factors  whose  associates,  implica- 
tions, or  effects  are  known,  but  in  addition  the  degree  of 
dependability  of  the  association  between  the  (estimated) 
factors  (the  immediately  perceptible  attributes  or  modes  of 
behavior)  and  the  inferred  factors  with  relation  to  which 
our  action  in  the  case  is  to  be  controlled.  Most  of  the  real 
decisions  of  life  are  based  on  "reasoning"  (if  such  it  may  be 
called)  of  this  still  more  tenuous  and  uncertain  character, 
and  not  even  that  which  has  already  been  described.  We 
have  to  estimate  the  given  factors  in  a  situation  and  also 
estimate  the  probability  that  any  particular  consequence 
will  follow  from  any  of  them  if  present  in  the  degree  as^- 
sumed. 

For  logical  accuracy  and  in  order  to  understand  the 
different  kinds  of  situations  and  modes  of  dealing  with 
them  in  practice,  a  further  distinction  must  be  drawn,  a 
distinction  of  far-reaching  consequences  and  much  neg- 
lected in  the  discussion  of  economic  problems.  There  are 
two  fundamentally  different  ways  of  arriving  at  the  proba- 
bility judgment  of  the  form  that  a  given  numerical  prp- 
b  portion  of  X's  are  also  Fs.  The  first  method  is  by  a  priori 
calculation,  and  is  applicable  to  and  used  in  games  of 
chance.  This  is  also  the  type  of  case  usually  assumed  in 
logical  and  mathematical  treatments  of  probability.  It 
must  be  strongly  contrasted  with  the  very  different  type  of 
^-^  problem  in  which  calculation  is  impossible  and  the  result  is 
i  £ )renohe.(\  by  the  empirical  method  of  applying  statistics  to 
actual  instances.    As  an  illustration  of  the  first  type  of 


MEANING  OF  RISK  AND  UNCERTAINTY      215 

probability  we  may  take  throwing  a  perfect  die.  If  the  die 
is  really  perfect  and  known  to  be  so,  it  would  be  merely 
ridiculous  to  undertake  to  throw  it  a  few  hundred  thousand 
times  to  ascertain  the  probability  of  its  resting  on  one  face 
or  another.  And  even  if  the  experiment  were  performed, 
the  result  of  it  would  not  be  accepted  as  throwing  any 
light  on  the  actual  probability.  The  mathematician  can 
easily  calculate  the  probability  that  any  proposed  dis- 
tribution of  results  will  come  out  of  any  given  number  of 
throws,  and  no  finite  number  would  give  certainty  as  to  the 
probable  distribution.  On  the  other  hand,  consider  the 
case  already  mentioned,  the  chance  that  a  building  will 
burn.  It  would  be  as  ridiculous  to  suggest  calculating  from 
a  priori  principles  the  proportion  of  buildings  to  be  acciden- 
tally destroyed  by  fire  in  a  given  region  and  time  as  it 
would  to  take  statistics  of  the  throws  of  dice. 

The  import  of  this  distinction  for  present  purposes  is 
that  the  first,  mathematical  ova  priori,  type  of  probability 
is  practically  never  met  with  in  business,  while  the  second 
is  extremely  common.  It  is  difficult  to  think  of  a  business 
"hazard"  with  regard  to  which  it  is  in  any  degree  possi- 
ble to  calculate  in  advance  the  proportion  of  distribution 
among  the  different  possible  outcomes.1  This  must  be 
dealt  with,  if  at  all,  by  tabulating  the  results  of  experience. 
The  "if  at  all"  is  an  important  reservation,  which  will  be 
discussed  presently.  It  is  evident  that  a  great  many  haz- 
ards  can  be  reduced  to  a  fair  degree  of  certainty  bvstatis- 
tical  grouping  —  also  that  an  equally  imporfrfi.nf.  ™.»pgnry 
cannot.  We  should  note,  however,  two  other  facts.  First, 
the  statistical  treatment  never  gives  closely  accurate 
quantitative  results.  Even  in  such  simple  cases  as  mechan- 
ical  games  of  chance  it  would  never  be  final,  short  of  an 
infinite  number  of  instances,  as  already  observed.  Fur- 
thermore, the  fact  that  a  priori  methods  are  inapplicable  is 

1  The  calling  of  bonds  by  lot  is  an  illustration.  In  Germany  bond- 
holders often  insure  against  this  chance. 


216  RISK,  UNCERTAINTY,  AND  PROFIT 

connected  with  a  much  greater  complication  in  the  data, 
which  again  carries  with  it  a  difficulty,  in  fact  impossibil- 
ity, of  securing  the  same  degree  of  homogeneity  in  the  in- 
stances classed  together.  This  point  will  have  to  be  gone 
into  more  fully.  The  second  fact  mentioned  in  regard  to 
the  two  methods  is  that  the  hazards  or  probabilities  met 
with  in  business  do  admit  of  a  certain  small  degree  of 
theoretical  treatment,  supplementing  the  application  of 
experience  data.  Thus  in  the  case  of  fire  risk  on  buildings, 
the  fact  that  the  cases  are  not  really  homogeneous  may  be 
offset  in  part  by  the  use  of  judgment,  if  not  calculation. 
It  is  possible  to  tell  with  some  accuracy  whether  the 
"real  risk"  in  a  particular  case  is  higher  or  lower  than  that 
of  a  group  as  a  whole,  and  by  how  much.  This  procedure, 
however,  must  be  treated  with  caution.  It  is  not  clear 
that  there  is  an  ultimate  separation  between  the  calcula- 
tion of  departures  from  a  standard  type  and  more  minute 
classification  of  types.  There  is,  however,  a  difference  in 
form,  and  insurance  companies  constantly  follow  both 
practices,  that  of  defining  groups  as  accurately  as  possible 
and  also  that  of  modifying  or  adjusting  the  coefficient  ap- 
plied within  a  class  according  to  special  circumstances 
which  are  practically  always  present. 

We  thus  find  that  there  are  two  logically  different  types 
of  inference  included  in  the  probability  judgment.  We  shall 
ref erfto  these  foT  brevity  under  the  names  of  the  "a  priori  " 
and/xhe  "statistical"  respectively.  The  relations  between 
thetwo  concepts  as  employed  in  the  crude  usage  of  com- 
mon sense  are  much  confused  and  the  ideas  themselves 
blurred,  so  that  it  is  important  to  emphasize  the  con- 
trast. The  precise  meaning  of  "real  probability"  will  have 
to  be  examined  more  in  detail  presently,  but  we  can  see 
that  there  is  a  difference  in  this  respect  in  our  feelings  to- 
ward the  two  classes  of  cases.  It  seems  clear  that  the  prob- 
ability of  getting  a  six  in  throwing  a  die  is  "really"  one  in 
six,  no  matter  what  actually  happens  in  any  particular 


MEANING  OF  RISK  AND  UNCERTAINTY       217 

number  of  throws;  but  no  one  would  assert  confidently  that 
the  chance  of  a  particular  building  burning  on  a  particular 
day  is  "really"  of  any  definite  assigned  value.  The  first 
statement  has  intuitive  certainty  with  reference  to  a  par- 
ticular instance;  in  case  of  the  second  it  is  merely  an  em- 
pirical generalization  with  reference  to  a  group.  Possibly 
the  difference  is  partly  a  matter  of  habit  in  our  thinking 
and  to  some  extent  illusory,  but  it  is  none  the  less  real  and 
functional  in  our  thinking.  There  is,  indeed,  a  sort  of 
logical  paradox  in  the  problem.  If  the  probability  in  a 
game  of  chance  is  questioned,  there  is  no  test  except  that  of 
experimental  trial  of  a  large  number  of  cases,  and  under 
some  circumstances  we  should  conclude  that  the  die  was 
probably  "loaded."  This  would  itself  be  a  probability 
judgment,  to  be  sure,  and  would  depend  on  the  fact  of  our 
ignorance  of  the  composition  and  manufacture  of  the  die. 
Given  this  ignorance,  a  mathematician  could  tell  the  prob- 
ability that  the  die  is  false,  indicated  by  any  given  number 
and  distribution  of  throws. 

The  practical  difference  between  a  priori  and  statistical  j  ( 
probability  seems  to  depend  upon  the  accuracy  of  classifi- 
cation  of  the  instances  grouped  together..  In  the  case  of 
the  die,  the  successive  throws  are  held  to  be  "alike"  in  a 
degree  and  a  sense  which  cannot  be  predicated  of  the  dift'er- 
ent  buildings  exposed  to  hrejiazard.  There  is,  of  course, 
a  constant  effort  on  the  part  of  the  actuary  to  make  his 
classifications  more  exact,  dividing  groups  into  subgroups 
to  secure  the  greatest  possible  homogeneity.  Yet  we  can 
hardly  conceive  this  process  being  carried  so  far  as  to  make 
applicable  the  idea  of  real  probability  in  a  particular  in- 
stance. 

There  is  a  further  (Jjffiqiltv.  amounting  to  paradox,  in 
the  idea  of  homogeneous  grouping.  Much  is  made  of  this 
point  in  treatises  on  statistics,  the  student  being  warned 
against  drawing  conclusions  from  distributions  in  non- 
homogeneous  groups.   Perhaps  the  most  familiar  example 


218  RISK,  UNCERTAINTY,  AND  PEG.  IT 

is  the  age  and  sex  distribution  of  population  aggregates. 
An  illustration  (used  by  Secrist)  is  the  death  rate  of  the 
American  soldiers  in  the  Philippines,  which  was  lower  than 
that  of  the  general  population  in  the  United  States.  The 
fallacy  in  the  inference  as  to  healthfulness  of  environment 
is,  of  course,  that  the  "general  population"  is  not  a  ho- 
mogeneous group,  but  is  made  up  of  numerous  age,  sex, 
race,  and  occupation  classes,  "naturally"  subject  to  widely 
different  death  rates.  The  paradox,  which  carries  us  at 
once  into  the  heart  of  the  logical  problem  of  probability,  is 
that  if  we  had  absolutely  homogeneous  groups  we  should 
have  uniformity  and  not  probability  in  the  result,  or  else 
we  must  repudiate  the  dogma  of  the  ultimate  uniformity  of 
nature,  the  persistence  of  identity  in  things.  If  the  idea  of 
natural  law  is  valid  at  all,  it  would  seem  that  men  exactly 
alike  and  identically  circumstanced  would  all  die  at  once; 
in  any  particular  interval  either  all  or  none  would  suc- 
cumb, and  the  idea  of  probability  becomes  meaningless. 
So  even  in  the  case  of  the  dice;  if  we  believe  in  the  postulates 
which  make  knowledge  possible,  then  dice  made  alike  and 
thrown  alike  will  fall  alike,  and  that  is  the  end  of  it. 

Yet  practically  there  is  no  danger,  figuratively  speak- 
ing, that  any  of  these  phenomena  will  ever  be  amenable  to 
prediction  in  the  individual  instance.  T?he  fundamental 
fact  underlying  probability  reasoning  is  generally  assumed 
tojbe  our  jgnorfl/nQp.  If  it  were  possible  to  measure  with 
absolute  accuracy  all  the  determining  circumstances  in 
the  case  it  would  seem  that  we  should  be  able  to  predict 
the  result  in  the  individual  instance,  but  it  is  obtrusively 
manifest  that  in  many  cases  we  cannot  do  this.  It  will  cer- 
tainly not  be  proposed  in  the  typical  insurance  situations, 
the  chance  of  death  and  of  fire  loss,  probably  not  even  in 
the  case  of  gambling  devices.  The  question  arises  whether 
we  should  draw  a  distinction  between  necessary  and  only 
factual  ignorance  of  the  data  in  a  given  case.  Take  the 
case  of  balls  in  an  urn.   One  man  knows  that  there  are 


MEANING  OF  RIS5  AND  UNCERTAINTY      219 

red  and  black  balls,  but  is  ignorant  of  the  numbers  of  each; 
another  knows  that  the  numbers  are  three  of  the  former  to 
one  of  the  latter.  It  may  be  argued  that  "to  the  first  man  " 
the  probability  of  drawing  a  red  ball  is  fifty-fifty,  while  to 
the  second  it  is  seventy-five  to  twenty-five.  Or  it  may  be 
contended  that  the  probability  is  "really"  in  the  latter 
ratio,  but  that  the  first  man  simply  does  not  know  it.  It 
must  be  admitted  that  practically,  if  any  decision  as  to 
conduct  is  involved,  such  as  a  wager,  the  first  man  would 
have  to  act  on  the  supposition  that  the  chances  are  equal. 
And  if  the  real  probability  reasoning  is  followed  out  to  its 
conclusion,  it  seems  that  there  is  "really"  no  probability  at 
all,  but  certainty,  if  knowledge  is  complete.  The  doctrine 
of  real  probability,  if  it  is  to  be  valid,  must,  iL  seems,  rest 
upon  inherent  unknowability  in  the  factors,  naljnerely_the 
fact  of  ignorance.  And  even  then  we  must  always  consult 
the  empirical  facts,  for  it  will  not  do  to  assume  out  of  hand 
that  the  unknown  causes  in  a  case  will  distribute  them- 
selves according  to  the  law  of  indifference  among  the  differ- 
ent instances.  We  seem  to  be  driven  back  to  a  logical 
impasse.  The  postulates  of  knowledge  generally  involve 
the  conclusion  that  it  is  really  determined  in  the  nature  of 
things  which  house  will  burn,  which  man  die,  and  which 
face  of  the  thrown  die  will  come  uppermost.  The  logic 
which  we  actually  use,  however,  assumes  that  the  result 
is  really  indeterminate,  that  the  unknowable  causes  ac- 
tually follow  a  law  of  indifference.  The  phenomenal  con- 
stancy of  distribution  to  which  we  are  forced  to  appeal 
justifies  this  reasoning  on  the  whole,  but  clearly  is  not  its 
actual  basis  in  our  thinking.  Wherever  we  find  that  there 
is  not  indifference,  that  the  results  show  "bias,"  we  as- 
sume some  determinable  cause  at  work;  and  the  results  of 
experience  on  the  whole  justify  this  assumption  also. 

There  is  a  further  point  of  some  interest  in  regard  to  our 
probability  reasoning.  Examination  of  the  mathematical 
theory  of  probability  will  show  that  the  argument  always 


220  RISK,  UNCERTAINTY,  AND  PROFIT 

proceeds  on  the  assumption  that  there  is  no  middle  ground 
between  complete  determination  and  complete  indifference. 
That  is,  the  elementary  probabilities  in  any  form  of  prob- 
lem must  always  be  equal.  If  the  chance  of  any  particular 
result  is  more  or  less  than  one  half,  it  is  held  to  be  axio- 
matic that  there  is  a  greater  number  of  possible  alternatives 
which  yield  this  result  (or  do  not  yield  it)  than  of  the  other 
kind;  the  alternatives  themselves  must  be  equally  probable. 
The  whole  mathematical  theory  of  probability  is  obviously 
a  simple  application  of  the  principles  of  permutations  and 
combinations  for  finding  out  the  number  of  alternatives. 
Absolute  indifference  between  the  alternatives  is  taken  for 
granted.  Wherever  the  results  do  not  show  complete  in- 
difference between  alternatives  it  is  assumed  that  these 
are  not  simple,  and  further  analysis  is  applied  to  reduce 
them  to  combinations  of  equally  possible  ones.  And  ex- 
perience confirms  these  assumptions  also. 

Are  we,  then,  to  assume  real  indeterminateness,  in  the 
cosmos  itself?  This  was  the  view  of  Cournot,  and  the  mere 
ignorance  theory  common  among  writers  on  probability 
seems  inadequate  and  untenable.  There  are,  to  be  sure, 
cases  which  it  seems  to  fit,  like  that  referred  to,  where  the 
probability  of  drawing  a  red  or  black  ball  is  even  to  one 
who  knows  only  that  there  are  balls  of  the  two  colors  in  the 
urn,  but  is  ignorant  of  the  numbers  of  each.1  But  the  case  of 
the  man  who  does  know  the  numbers  of  each  seems  to  be 
different.  The  dogmatic  determinist  can  always  maintain 
that  there  are  causes  at  work  which  decide  the  result,  but 
common  sense  is  not  satisfied.  How  does  it  "happen" 
that  experience  justifies  the  calculation  of  probabilities 
unless  these  unknown  causes  are  really  indifferent?  When- 
ever we  find  "biflg"  in  the  rpg]ilt,fi,  p  divergence  from  the 
anticipations  on  the  basis  of  probability  theory,  we  assume 

1  Professor  Irving  Fisher  is  particularly  insistent  upon  the  interpreta- 
tion of  probability  as  due  to  ignorance  alone.  See  The  Nature  of  Capital 
and  Income,  chap,  xvi,  sec.  1. 


MEANING  OF  RISK  AND  UNCERTAINTY      221 

the  presence  of  some  cause  which  is  not  indifferent,  and 
this  procedure  is  also  justified  of  its  fruits.  When  we  can  be 
sure  that  we  have  eliminated  every  circumstance  which 
can  be  measured  or  which  might  act  consistently,  we  feel 
confident  in  assuming  that  in  a  large  number  ofjtriajs_the 
results  will  come  out  in  accordance  with  the  assumption 
that  the  factors  not  subject  to  measurement  or  elimination 
are  in  fact  indifferent^  And  not  merely  do  we  feel  this  way, 
but  "it  works." 

It  is  interesting  to  observe  that  the  common  applications 
of  probability  in  games  of  chance  relate  to  some  action  of 
the  human  organism  itself,  the  drawing  of  a  card  from  a 
deck  or  ball  from  an  urn  after  random  manipulations,  the 
impulse  given  to  a  wheel  or  coin  or  die,  etc.  The  facts 
suggest  a  connection  with  that  other  age-old  bone  of  con- 
tention, the  freedom  of  the  will.1  If  there  is  real  indeter- 
minateness,  and  if  the  ultimate  seat  of  it  is  in  the  activities 
of  the  human  (or  perhaps  organic)  machine,  there  is  in  a 
sense  an  opening  of  the  door  to  a  conception  of  freedom  in 
conduct.  And  when  we  consider  the  mystery  of  the  role  of 
consciousness  in  behavior  and  the  repugnance  which  is  felt 
by  common  sense  to  the  epiphenomenal  theory,  we  feel 
justified  in  further  contending  for  at  least  the  possibility 
that  "mind"  may  in  some  inscrutable  way  originate  action. 
Just  how  much  or  what  sort  of  significance  the  admission 
may  have  for  practical  ethics  is  another  question,  which 
must  be  passed  over  here.  Of  course  we  cannot  prove  that 
the  exact  distribution  of  all  the  coups  of  the  roulette  wheels 
at  Monte  Carlo  was  not  stowed  away  somewhere  in  the 
primeval  nebula;  the  final  appeal  must  be  to  "intrinsic 
reasonableness,"  the  inveterate  and  necessary  preference  of 
intelligence  for  the  simplest  formulation  which  conforms 
to  the  facts.  And  about  this,  there  may  indeed  be  differences 
of  opinion,  and  from  these  there  is  apparently  no  appeal.2 

1  Cf.  E.  Borel,  Le  Hasard,  pp.  196-97. 

2  See  Karl  Pearson's  essay  on  "The  Scientific  Aspects  of  Monte  Carlo 


222  RISK,  UNCERTAINTY,  AND  PROFIT 

There  may  be  different  brands  of  "common  sense" 
(which  some  wag  has  averred  is  so  called  because  so  very- 
uncommon).  In  the  writer's  view  the  doctrine  of  igno- 
rance or  "insufficient  reason"  is  untrue  to  the  feelings  of 
unsophisticated  intelligence.  We  do  not  merely  feel  that 
we  know  no  reason  why  the  coin  shall  fall  heads  or  tails; 
we  know  in  a  positive  sense  that  there  is  no  reason^smd  only 
under  this  condition  do  we  make  the  probability  judgment 
with  any  confidence.  And  furthermore,  as  already  argued, 
it  appears  that  only  on  condition  that  there  is  no  reason 
would  the  results  of  experience  confirm  the  judgment,  as 
they  do.  The  entire  science  of  probability  in  the  mathemat- 
ical  sense  is  based  on  the  dogmatic  assumption  that  the 
ultimate  alternatives  are  really  equally  vrobable.  which 
seems  to  the  writer  to  mean  real  indeterminateness.1 

Professor  Irving  Fisher's  view  of  probability  as  "always 
an  estimate  "  becomes  conditionally  valid,  however,  on  two 
interpretations.  In  the  first  place,  it  may  be  saved  "theo- 
retically" if  the  term  "estimate"  is  construed  broadly 
enough.  If  there  is  no  difference  between  our  a  priori 
judgment  of  the  absence  of  any  cause  which  should  lead  a 

Roulette,"  in  The  Chances  of  Death  and  Other  Studies  in  Evolution.  The 
necessity  of  constant  appeal  to  a  dogmatic  preference  of  simple  to  com- 
plicated hypotheses  is  brilliantly  treated  in  Poincare's  chapter  on  "Prob- 
abilities," in  The  Foundations  of  Science,  Science  and  Hypothesis,  chap, 
xi.  See  also  Poincare's  fascinating  treatment  of  the  relations  between 
small  causes  and  large  effects  in  the  same  volume,  Science  and  Method, 
chap.  iv.  Poincare  bases  the  doctrine  of  equal  probability  on  the  mathe- 
matical principle  that  for  small  changes  any  continuous  analytical  func- 
tion changes  in  the  same  ratio  as  the  variable.  The  same  unsatisfactory, 
if  not  absurd,  doctrine  of  "intrinsic  reasonableness"  (for  how  can  one 
thing  be  "intrinsically"  more  probable  than  another?)  is  developed  from 
a  different  point  of  view  in  Balfour's  Theism  and  Humanism,  lecture 
vii,  on  "Probability,  Calculable  and  Intuitive." 

1  For  an  excellent  brief  discussion  of  the  issue,  with  references  to  the 
literature,  the  reader  is  referred  to  Arne  Fisher,  The  Mathematical  Theory 
of  Probability,  chap,  i:  "General  Principles  and  Philosophic  Aspects." 
The  writer's  position  is  that  taken  by  Fisher  and  designated  the  principle 
of  "cogent  reason"  in  opposition  to  the  older  view  common  among 
mathematicians,  of  "insufficient  reason."  Compare  also  La  Place, 
Essay  on  the  Philosophical  Theory  of  Probability. 


MEANING  OF  RISK  AND  UNCERTAINTY      223      (. 

coin  or  a  die  to  fall  on  one  face  rather  than  another  and  an 
"estimate"  of  equal  probability,  then  there  is  no  opposi- 
tion between  the  two  views.  This  is,  however,  repugnant 
to  common  sense  (the  present  writer's  brand).  We  seem 
to  experience  an  "apodeictic  certainty"  about  the  situa- 
tion of  a  game  of  chance,  on  a  level  with  our  confidence  in 
the  axioms  of  mathematics,  and  quite  different  from  an 
"estimate."  To  illustrate,  suppose  we  are  allowed  to  look 
into  the  urn  containing  a  large  number  of  black  and  red 
balls  before  making  a  wager,  but  are  not  allowed  to  count 
the  balls;  this  would  give  rise  to  an  estimate  of  probability 
in  the  correct  sense;  it  is  something  very  different  from 
either  the  mere  consciousness  or  ignorance  on  which  we 
act  if  we  know  only  that  there  are  balls  of  both  colors 
without  any  knowledge  or  opinion  as  to  the  numbers  or 
the  exact  knowledge  of  real  probability  attained  by  an 
accurate  counting  of  the  balls.  In  the  second  place,  we 
must  admit  that  the  actual  basis  of  action  in  a  large  pro- 
portion of  real  cases  is  an  estimate.  Neither  of  these  inter- 
pretations, however,  justifies  identifying  probability  with 
an  estimate. 

But  the  probability^  which  the  student,  of  business 
risk  is  interested  is  an  estimate,  though  in  a  sense  different 
from  any  of  the  propositions  so  far  considered.  To  discuss 
the  question  from  this  new  point  of  view  we  must  go  back 
for  a  moment  to  the  general  principles  of  the  logic  of  con- 
duct. We  have  emphasized  above  that  the  exact  science  of 
inference  has  little  place  in  forming  the  opinions  upon 
which  -decisions  of  conduct  are  based,  and  that  this  is  true 
whether  the  implicit  logic  of  the  case  is  prediction  on  the 
ground  of  exhaustive  analysis  or  a  probability  judgment, 
a  priori  or  statistical.  We  act  upon  estimates  rather  than 
inferences,  upon  "judgment"  or  "intuition,"  not  reason- 
ingJFor  the  most  part.  Now  an  estimate  or  intuitive  judg- 
ment is  somewhat  like  a  probability  judgment,  but  very 
different  from  either  of  the  types  of  probability  judg- 


224  RISK,  UNCERTAINTY,  AND  PROFIT 

ment  already  described.  The  relations  between  the  two 
sorts"  are  in  fact  amazingly  complex  and  as  fraught  with 
logical  paradox  as  the  probability  judgment  itself.  If  the 
term  "probability"  is  to  be  applied  to  an  estimate  —  and 
the  usage  is  so  well  established  that  there  is  no  hope  of 
getting  away  from  it  —  a  third  species  under  that  genus 
must  be  recognized.  Such  a  third  type  of  probability  fits 
very  nicely  in  a  scheme  of  classification  with  the  two  al- 
ready discussed.  We  have  insisted  that  there Jsjl  funda- 
mental difference  between  "a  priori"  probability,  on  the 
one  hand,  and  "statistical,"  on  the  other.  In  the  former 
the  "chances"  can  be  computed  on  general  principles, 
while  in  the  latter  they  can  only  be  determined  empirically. 
This  distinction  is  in  opposition  to  the  views  of  writers 
such  as  Venn  and  Edgeworth,1  who  reduce  the  former 
type  to  the  latter  on  the  basis  of  an  empirical  law  of  large 
numbers  and  accept  practically  the  assumption  of  real 
indeterminateness.  We  have  already  raised  the  question 
of  accuracy  of  classification  in  this  connection,  suggesting 
that  the  "instances,"  "throws,"  or  "coups"  in  a  game  of 
chance  form  a  homogeneous  group  in  a  higher  sense  than 
can  be  predicated  on  life  or  fire  hazards.  This  view  and  our 
entire  theory  tend  to  be  confirmed  by  the  attempt  to 
secure  complete  homogeneity  through  more  minute  clas- 
sification. The  end  result  of  this  endeavor  would  be  group- 
ings in  which  only  really  indeterminate  factors  should 
differ  from  one  instance  to  another. 

Taking,  then,  the  classification  point  of  view,  we  shall 
find  the  following  simple  scheme  for  separating  three  differ- 
ent types  of  probability  situation : 

1.  A  pnon^rjiobability.  Absolutely  homogeneous  clas- 
sification of  instances  completely  identical  except  for 
really  indeterminate  factors.  This  judgment  of  prob- 
ability is  on  the  same  logical  plane  as  the  propositions 
of  mathematics  (which  also  may  be  viewed,  and  are 
1  "The  Philosophy  of  Chance,"  Mind,  vol.  9,  1884. 


MEANING  OF  RISK  AND  UNCERTAINTY       225 

viewed  by  the  writer,  as  "ultimately"  inductions 
from  experience). 

2.  Statistical  probability.  Empirical  evaluation  of  the 
frequency  of  association  between  predicates,  not  an- 
alyzable  into  varying  combinations  of  equally  prob- 
able alternatives.  It  must  be  emphasized  that  any 
high  degree  of  confidence  that  the  proportions  found 
in  the  past  will  hold  in  the  future  is  still  based  on  an 
a  priori  judgment  of  indeterminateness.  Two  com- 
plications are  to  be  kept  separate:  firsts  the  impos- 
sibility  of  eliminating  all  factors  not  really  indeter- 
minate;  andl  feeconcLtne  impossibility  of  enumerating 
the  equally  probable  alternatives  involved  and 
determining  their  mode  of  combination  so  as  .to 
evaluate  the  probability  by  a  priori  calculation.  The 
main  distinguishing  characteristic  of  this  type  is  that 
it  rests  on  an  empirical  classification  of  instances. 

3.  Estimates.  The  distinction  here  is  that  there  is  no 
valid  basis  of  any  kind  for  classifying  instances.  This 
form"ofpSobability  is  involved  in  the  greatest  logical 
difficulties  of  all,  and  no  very  satisfactory  discussion 
of  it  can  be  given,  but  its  distinction  from  the  other 
types  must  be  emphasized  and  some  of  its  com- 
plicated relations  indicated. 

We  know  that  estimates  or  judgments  are  "liable"  to 
err.  Sometimes  a  rough  determination  of  the  magnitude  of 
this  "liability"  is  possible,  but  more  generally  it  is  not.  In 
general,  any  determination  of  the  value  of  an  estimate 
must  be  merely  empirical,  secured  by  the  tabulation  of 
instances,  thus  reducing  it  to.  a  probability  of  the  second  or 
statistical  type.  Indeed,  since,  as  we  have  noticed,  entirely 
homogeneous  classification  of  instances  is  practically  never 
possible  in  dealing  with  statistical  probability,  it  is  clear 
that  the  divergence  from  it  of  this  third  type  where  all 
classification  is  excluded  is  a  matter  of  degree  only.  There 
are  all  gradations  from  a  perfectly  homogeneous  group  of 


226  RISK,  UNCERTAINTY,  AND  PROFIT 

life  or  fire  hazards  at  one  extreme  to  an  absolutely  unique 
exercise  of  judgment  at  the  other.  All  gradations,  we 
should  say,  except  the  ideal  extremes  themselves;  for  as 
we  can  never  in  practice  secure  completely  homogeneous 
classes  in  the  one  case,  so  in  the  other  it  probably  never 
happens  that  there  is  no  basis  of  comparison  for  determin- 
ing the  probability  of  error  in  a  judgment. 

The  theoretical  difference  between  the  probability 
connected  with  an  estimate  and  that  involved  in  such 
phenomena  as  are  dealt  with  by  insurance  is,  however,  of 
the  greatest  importance,  and  is  clearly  discernible  in  nearly 
any  instance  of  the  exercise  of  judgment.  Take  as  an  illus- 
tration any  typical  business  decision.  A  manufacturer  is 
considering  the  advisability  of  making  a  large  commit- 
ment in  increasing  the  capacity  of  his  works.  He  "figures'* 
more  or  less  on  the  proposition,  taking  account  as  well  as 
possible  of  the  various  factors  more  or  less  susceptible  of 
measurement,  but  the  final  result  is  an  "estimate"  of  the 
probable  outcome  of  any  proposed  course  of  action.  What 
is  the  "  probability "  of  error  (strictly,  of  any  assigned  de- 
gree of  error)  in  the  judgment?  It  is  manifestly  meaning- 
less to  speak  of  either  calculating  such  a  probability  a 
priori  or  of  determining  it  empirically  by  studying  a  large 
number  of  instances.  The  essential  and  outstanding  fact 
is  that  the  "instance"  in  question  is  so  entirely  unique  that 
there  are  no  others  or  not  a  sufficient  number  to  make  it 
possible  to  tabulate  enough  like  it  to  form  a  basis  for  any 
inference  of  value  about  any  real  probability  in  the  case  we 
are  interested  in.  The  same  obviously  applies  to  the  most 
of  conduct  and  not  to  business  decisions  alone. 

Yet  it  is  true,  and  the  fact  can  hardly  be  over-em- 
phasized, that  a  judgment  of  probability  is  actually  made 
in  such  cases.  The  business  man  himself  not  merely  forms 
the  best  estimate  he  can  of  the  outcome  of  his  actions,  but 
he  is  likely  also  to  estimate  the  probability  that  his  esti- 
mate is  correct.  The  "  degree  "  of  certainty  or  of  confidence 


MEANING  OF  RISK  AND  UNCERTAINTY      <m 

felt  in  the  conclusion  after  it  is  reached  cannot  be  ignored, 
for  it  is  of  the  greatest  practical  significance.  The  action 
which  follows  upon  an  opinion  depends  as  much  upon  the 
amount  of  confidence  in  that  opinion  as  it  does  upon  the 
favorableness  of  the  opinion  itself.  The  ultimate  logic,  or  . 
psychology,  of  these  deliberations  is  obscure,  a  part  of  the 
scientifically  unfathomable  mystery  of  life  and  mind.  We 
must  simply  fall  back  upon  a  "  capacity  "  in  the  intelligent 
animal  to  form  more  or  less  correct  judgments  about  things, 
an  intuitive  sense  of  values.  We  are  so  built  that  what 
seems  to  us  reasonable  is  likely  to  be  confirmed  by  expe- 
rience, or  we  could  not  live  in  the  world  at  all. 

Fidelity  to  the  actual  psychology  of  the  situation  re- 
quires, we  must  insist,  recognition  of  these  two  separate 
exercises  of  judgment,  the  formation  of  an  estimate  and  the 
estimation  of  its  value.  We  must,  therefore,  disagree  with 
Professor  Irving  Fisher's  contention  -1  that  there  is  only 
one  estimate,  the  subjective  feeling  of  probability  itself. 
Moreover,  it  appears  that  the  original  estimate  maybe  a 
probability  judgment.  A  man  may  act  upon  an  estimate 
of  the  chance  that  his  estimate  of  the  chance  of  an  event  is 
a  correct  estimate.  To  be  sure,  after  the  decision  is  made 
he  will  be  likely  to  sum  all  up  in  a  certain  degree  of  con- 
fidence that  a  certain  outcome  will  be  realized,  and  in 
practice  may  go  farther  and  assume  that  the  outcome 
itself  is  a  certainty. 

Two  sorts  of  difficulty  tend  to  obscure  the  relation  be- 
tween our  second  and  third  types  of  probability,  that  which 
rests  upon  an  empirical  classification  of  instances  and  that 
which  rests  upon  no  classification,  but  is  an  estimate  of  an 
estimate.  In  the  first  place,  nothing  in  the  universe  of 
experience  is  absolutely  unique  any  more  than  any  two 
things  are  absolutely  alike.  Consequently  it  is  always  pos- 
sible to  form  classes  if  the  bars  are  let  down  and  a  loose 
enough  interpretation  of  similarity  is  accepted.  Thus,  in 
1  See  The  Nature  of  Capital  and  Income,  p.  266. 


228  RISK,  UNCERTAINTY,  AND  PROFIT 

the  case  above  mentioned,  it  might  or  might  not  be 
entirely  meaningless  to  inquire  as  to  the  proportion  of 
successful  factory  extensions  and  the  proportion  of  those 
which  are  not.  In  this  particular  case  it  is  hard  to  imagine 
that  any  one  would  base  conduct  upon  a  judgment  of  the 
probability  of  success  arrived  at  in  this  way,  but  in  other 
situations  the  method  could  conceivably  have  more  or  less 
validity.  We  must  keep  in  mind  that  for  conduct  a  proba- 
bility judgment  based  on  mere  ignorance  may  be  deter- 
mining if  it  is  the  best  that  can  be  had.  It  would  be  a 
question,  however,  whether  the  person  placed  in  the  posi- 
tion of  our  business  manager  should  regard  the  probability 
for  him  of  success  as  that  indicated  by  statistics  of  "simi- 
lar" instances  or  simply  even  chances  each  way  based  on 
the  fact  of  pure  ignorance.  What  does  appear  certain  is 
that  his  own  estimate  of  the  value  of  his  own  judgment 
would  be  given  far  greater  weight  than  either  sort  of 
computation. 

A  still  more  interesting  complication,  and  one  of  much 
greater  practical  significance,  is  the  possibility  of  forming  a 
class  of  similar  instances  on  entirely  different  grounds.  That 
is,  instead  of  taking  the  decisions  of  other  men  in  situations 
more  or  less  similar  objectively,  we  may  take  decisions  of 
the  same  man  in  all  sorts  of  situations.  It  is  indisputable 
that  this  procedure  is  followed  in  fact  to  a  very  large  extent 
and  that  an  astounding  number  of  decisions  actually  rest 
upon  such  a  probability  judgment,  though  it  cannot  be 
placed  in  the  form  of  a  definite  statistical  determination. 
That  is,  men  do  form,  on  the  basis  of  experience,  more  or 
less  valid  opinions  as  to  their  own  capacity  to  form  correct 
judgments,  and  even  of  the  capacities  of  other  men  in  this 
regard.  To  be  sure,  both  bases  of  classification  are  more  or 
less  taken  into  account;  the  estimate  (by  A  or  any  one  else) 
of  the  probability  that  the  outcome  of  a  situation  will  be 
that  which  A  has  predicted  is  not  based  on  a  perfectly  gen- 
eral estimate  of  A's  capacity  to  form  judgments,  but  of  his 


MEANING  OF  RISK  AND  UNCERTAINTY      229 

powers  in  a  more  or  less  defined  field  of  prediction.  It  will 
at  once  occur  to  the  reader  that  this  capacity  for  forming 
correct  judgments  (in  a  more  or  less  extended  or  restricted 
field)  is  the  principal  fact  which  makes  a  man  serviceable 
in  business;  it  is  the  characteristic  human  activity,  the 
most  important  endowment  for  which  wages  are  received. 
The  stability  and  success  of  business  enterprise  in  general 
is  largely  dependent  upon  the  possibility  of  estimating  the 
powers  of  men  in  this  regard,  both  for  assigning  men  to 
their  positions  and  for  fixing  the  remunerations  which  they 
are  to  receive  for  filling  positions.  The  judgment  or  esti- 
mate as  to  the  value  of  a  man  is  a  probability  judgment  of 
a  complex  nature,  indeed.  More  or  less  based  on  experi- 
ence and  observation  of  the  outcome  of  his  predictions, 
it  is  doubtless  principally  after  all  simply  an  intuitive  judg- 
ment or  "unconscious  induction,"  as  one  prefers. 
z  It  seems  likely  that  a  still  further  distinction  may  be 
drawn,  leading  to  the  recognition  of  another  basis  of  clas- 
sification of  instances  in  order  to  reach  a  probability  judg- 
ment. We  mean  the  subjective  feeling  of  confidence  of  the 
person  making  a  prediction.  I  may  have  an  intuitive  feel- 
ing or  "hunch"  that  a  situation  will  eventuate  in  a  cer- 
tain way,  and  this  feeling  may  inspire  a  more  or  less  delib- 
erative confidence  by  its  very  strength  and  persistence. 
The  confidence  in  a  prediction  which  is  based  on  the 
strength  of  an  intuition  may  appear  to  be  compounded  to 
the  point  of  nonsense,  but  in  so  far  as  there  exist  such  feel- 
ings reached  unconsciously  or  without  deliberation  and  in 
so  far  as  they  may  become  the  objects  of  deliberative  con- 
templation, the  situation  is  none  the  less  real.  However, 
we  cannot  extend  our  inquiry  to  cover  all  the  grounds  on 
which  men,  even  educated  men,  actually  make  decisions, 
or  it  will  degenerate  into  a  catalogue  of  superstitions.  Let 
us  try,  then,  to  sum  up  the  conclusions,  significant  for 
present  purposes,  to  which  the  argument  of  the  chapter 
leads. 


230  RISK,  UNCERTAINTY,  AND  PROFIT 

The  importance  of  uncertainty  as  a  factor  interfering 
with  the  perfect  workings  of  competition  in  accordance 
with  the  laws  of  pure  theory  necessitated  an  examination 
of  foundations  of  knowledge  and  conduct.  The  most  im- 
portant result  of  this  survey  is  the  emphatic  contrast  be- 
tween knowledge  as  the  scientist  and  the  logician  of  science 
uses  the  term  and  the  convictions  or  opinions  upon  which 
conduct  is  based  outside  of  laboratory  experiments.  The 
opinions  upon  which  we  act  in  everyday  affairs  and  those 
which  govern  the  decisions  of  responsible  business  mana- 
gers for  the  most  part  have  little  similarity  with  conclu- 
sions reached  by  exhaustive  analysis  and  accurate  measure- 
ment. The  mental  processes  are  entirely  different  in  the 
two  cases.  In  everyday  life  they  are  mostly  subconscious. 
We  know  as  little  why  we  expect  certain  things  to  happen 
as  we  do  the  mechanism  by  which  we  recall  a  forgotten 
name.  There  is  doubtless  some  analogy  between  the  sub- 
conscious processes  of  "intuition"  and  the  structure  of 
logical  deliberation,  for  the  function  of  both  is  to  anticipate 
the  future  and  the  possibility  of  prediction  seems  to  rest 
upon  the  uniformity  of  nature.  Hence  there  must  be,  in  the 
one  case  as  in  the  other,  some  sort  and  amount  of  analysis 
and  synthesis;  but  the  striking  feature  of  the  judging 
faculty  is  its  liability  to  error. 

The  real  logic  or  psychology  of  ordinary  conduct  is 
rather  a  neglected  branch  of  inquiry,  logicians  having 
devoted  their  attention  more  to  the  structure  of  demonstra- 
tive reasoning.  This  is  in  a  way  inevitable,  since  the  proc- 
esses of  intuition  or  judgment,  being  unconscious,  are  in- 
accessible to  study.  Such  attention  as  has  been  given  to 
the  problem  of  intuitive  estimation  has  been  connected 
with  and  largely  vitiated  by  confusion  with  the  logic  of 
CL  probability.  A  brief  examination  of  the  probability  judg- 
J>  ment  shows  it  to  fall  into  two  types,  which  we  called  the 
a  priori  and  the  statistical.  In  the  latter  type  of  situation, 
we  cannot,  as  we  can  in  the  former,  calculate  the  true 


l/ 


MEANING  OF  RISK  AND  UNCERTAINTY      231 

probabilit  *  from  external  data,  but  must  derive  it  from  an  A 
inductive  study  of  a  large  group  of  cases.  This  limitation  ' 
involves  a  serious  logical  weakness,  since  at  best  statistics 
give  but  a  probability  as  to  what  the  true  probability  is. 
In  practice  we  are  still  further  handicapped  by  the  im- 
possibility of  attaining  complete  homogeneity  in  our 
groups  of  instances,  in  the  sense  in  which  the  "coups"  in 
a  priori  probability  are  homogeneous;  that  is,  that  the 
divergences  are  practically  indeterminate  as  well  as  un- 
determined. 

The  liability  of  opinion  or  estimate  to  error  must  be 
radically  distinguished  from  probability  or  chance  of  either 
type,  for  there  is  no  possibility  of  forming  in  any  way 
groups  of  instances  of  sufficient  homogeneity  to  make 
possible  a  quantitative  determination  of  true  probability. 
Business  decisions,  for  example,  deal  with  situations  which 
are  far  too  unique,  generally  speaking,  for  any  sort  of 
statistical  tabulation  to  have  any  value  for  guidance.  The 
conception  of  an  objectively  measurable  probability  or 
chance  is  simply  inapplicable.  The  confusion  arises  from 
the  fact  that  we  do  estimate  the  value  or  validity  or  de- 
pendability of  our  opinions  and  estimates,  and  such  an 
estimate  has  the  same  form  as  a  probability  judgment;  it 
is  a  ratio,  expressed  by  a  proper  fraction.  But  in  fact  it 
appears  to  be  meaningless  and  fatally  misleading  to  speak 
of  the  probability,  in  an  objective  sense,  that  a  judgment  is 
correct.  As  there  is  little  hope  of  breaking  away  from  well- 
established  linguistic  usage,  even  when  vicious,  we  propose 
to  call  the  value  of  estimates  a  third  type  of  probability 
judgment,  insisting  on  its  differences  from  the  other  types 
rather  than  its  similarity  to  them. 

It  is  this  third  type  of  probability  or  uncertainty  which 
has  been  neglected  in  economic  theory,  and  which  we  pro- 
pose to  put  in  its  rightful  place.  As  we  have  repeatedly 
pointed  out,  an  uncertainty  which  can  by  any  method 
be  reduced  to  an  objective,  quantitatively  determinate 


2S2  RISK,  UNCERTAINTY,  AND  PROFIT 

probability,  can  be  reduced  to  complete  ceiJ:ainty  by 
grouping  cases.  The  business  world  has  evolved  several 
organization  devices  for  effectuating  this  consolidation, 
with  the  result  that  when  the  technique  of  business  or- 
ganization is  fairly  developed,  measurable  uncertainties 
do  not  introduce  into  business  any  uncertainty  whatever. 
Later  in  our  study  we  shall  glance  hurriedly  at  some  of 
these  organization  expedients,  which  are  the  only  economic 
effect  of  uncertainty  in  the  probability  sense;  but  the  pres- 
ent and  more  important  task  is  to  follow  out  the  con- 
sequences of  that  higher  form  of  uncertainty  not  suscepti- 
ble to  measurement  and  hence  to  elimination.  It  is  this 
true  uncertainty  which  by  preventing  the  theoretically  per- 
fect outworking  of  the  tendencies  of  competition  gives  the 
characteristic  form  of  "enterprise*'  to  economic  organiza- 
tion as  a  whole  and  accounts  for  the  peculiar  income  of  the 
entrepreneur. 


CHAPTER  VIII 

STRUCTURES  AND  METHODS  FOR  MEETING 
UNCERTAINTY 

To  preserve  the  distinction  which  has  been  drawn  in  the 
last  chapter  hejween  the  naeasurable  uncertainty  and  an 
unmeasurable  onj)  we  may  use  the  term  "risk"  to  designate 
the  former  and  the  term  "uncertainty"  for  the  latter.  The 
word  "risk"  is  ordinarily  used  in  a  loose  way  to  refer  to  any 
sort  of  uncertainty  viewed  from  the  standpoint  of  the  un- 
favorable contingency,  and  the  term  "uncertainty"  sim- 
ilarly with  reference  to  the  favorable  outcome;  we  speak  of 
the  "risk"  of  a  loss,  the  "uncertainty"  of  a  gain.  But  if 
our  reasoning  so  far  is  at  all  correct,  there  is  a  fatal  am- 
biguity in  these  terms,  which  must  be  gotten  rid  of,  and  the 
use  of  the  term  "risk"  in  connection  with  the  measurable 
uncertainties  or  probabilities  of  insurance  gives  some  jus- 
tification for  specializing  the  terms  asjust  indicatej^  We 
can  also  employ  the  terms  j^oSjectiy^^  and  (^subject  ivgT 
probability  to  designate  the  ^isk  ^nd  uncertainty}  respec- 
tively,  as  these  expressions  are  already  ingenefaT  use  with 
a  signification  akin  to  that  proposed. 

The  practical  difference  between  the  two  categories,  risk 
and  uncertainty,  is  that  in  the  former  the  distribution  of 
the,  outcome  in  a  group  of  instances  is  known  (either 
through  calculation*  a  priori  j©r  from  statistics  of  past  ex- 
perience), while  in  the  case  of  uncertainty  this  is  not  true, 
the  reason  being  in  general  that  it  is  impossible  to  form 
a  group  of  instances,  because  the  situation  dealt  with  is  in  a 
high  degree  unique.  The  best  example  of  uncertainty  is  in 
connection  with  the  exercise  of  judgment  or  the  formation 
of  those  opinions  as  to  the  future  course  of  events,  which 
opinions  (and  not  scientific  knowledge)  actually  guide 
most  of  our  conduct.  Now  if  the  distribution  of  the  differ- 


234  RISK,  UNCERTAINTY,  AND  PROFIT 

ent  possible  outcomes  in  a  group  of  instances  is  known,  it 
is  possible  to  get  rid  of  any  real  uncertainty  by  the  expe- 
dient of  grouping  or  "consolidating"  instances.  But  that 
it  is  possible  does  not  necessarily  mean  that  it  will  be  done, 
and  we  must  observe  at  the  outset  that  when  an  individual 
instance  only  is  at  issue,  there  is  no  difference  for  conduct 
between  a  measurable  risk  and  an  unmeasurable  uncer- 
tainty. The  individual,  as  already  observed,  throws  his 
estimate  of  the  value  of  an  opinion  into  the  probability 
form  of  "a  successes  in  b  trials"  (a/b  being  a  proper  frac- 
tion) and  "feels  "  toward  it  as  toward  any  other  probability 
situation. 

As  so  commonly  in  this  subject  fraught  with  logical 
difficulty  and  paradox,  reservations  must  be  made  to  the 
above  statement.  In  the  first  place,  it  does  not  matter  how 
unique  the  instance,  if  a  real  probability  can  be  calculated, 
if  we  can  know  with  certainty  how  many  successes  there 
would  be  in  (say)  one  hundred  trials  if  the  one  hundred 
trials  could  be  made.  If  we  know  the  odds  against  us  it 
does  not  matter  in  the  least  whether  we  place  all  our  wagers 
in  one  kind  of  game  or  in  as  many  different  games  as  there 
are  wagers;  the  laws  of  probability  hold  in  the  second  case 
just  as  well  as  in  the  first.  But  in  business  situations  it  so 
rarely  happens  that  a  probability  can  be  computed  for 
a  single  unique  instance  that  this  qualification  has  less 
weight  than  might  be  supposed.  However,  in  so  far  as  ob- 
jective probability  enters  into  a  calculation,  it  is  hard  to 
imagine  an  intelligent  individual  considering  any  single 
case  as  absolutely  isolated.  The  only  exception  would  be  a 
decision  in  which  one's  whole  fortune  (or  his  life)  were  at 
stake.  The  importance  of  the  contingency  and  probable 
frequency  of  recurrence  in  the  individual  lifetime  of  situa- 
tions similar  in  the  magnitude  of  the  issues  involved  should 
make  a  difference  in  the  attitude  assumed  toward  any  one 
case  as  well  as  the  mathematical  probability  of  success  or 
failure. 


METHODS  FOR  MEETING  UNCERTAINTY      235 

A  second  reservation  of  more  importance  is  connected 
with  the  possibility  referred  to  in  the  preceding  chapter,  of 
forming  classes  of  cases  by  grouping  the  decisions  of  a  given 
person.  That  is,  even  though  we  do  not  get  a  quantitative 
probability  by  the  process  of  grouping,  still  there  is  some 
tendency  for  fluctuations  to  cancel  out  and  for  the  result 
to  approach  constancy  in  some  degree.  There  appear  to 
be  in  the  making  of  judgments  the  same  two  kinds  of 
elements  that  we  find  in  probability  situations  proper; 
i.e.,  (a)  determinate  factors  (the  quality  of  the  judging 
faculty,  which  is  more  or  less  stable)  and  (b)  truly  acci- 
dental factors  varying  from  one  decision  to  another  accord- 
ing to  a  principle  of  indifference.  The  difference  between 
the  uncertainty  of  an  opinion  and  a  true  probability  is  that 
we  have  no  means  of  separating  the  two  and  evaluating 
them,  either  by  calculation  a  priori  or  by  empirical  sorting. 
But  in  the  second  case  the  difference  is  not  absolute;  the 
sorting  method  does  apply  to  some  extent,  though  within 
narrow  limits.  Life  is  mostly  made  up  of  uncertainties, 
and  the  conditions  under  which  an  error  or  loss  in  one  case 
may  be  compensated  by  other  cases  are  bafflingly  complex. 
We  can  only  say  that  "in  so  far  as"  one  confronts  a  situa- 
tion involving  uncertainty  and  deals  with  it  on  its  merits 
as  an  isolated  case,  it  is  a  matter  of  practical  indifference 
whether  the  uncertainty  is  measurable  or  not. 

The  problem  of  the  human  attitude  toward  uncertainty 
(not  for  the  present  purpose  distinguishing  kinds)  is  as 
beset  with  difficulties  as  that  of  uncertainty  itself.  Not 
merely  is  the  human  reaction  to  situations  of  this  character 
apt  to  be  erratic  and  extremely  various  from  one  individual 
to  another,  but  the  " normal' '  reaction  is  subject  to  well- 
recognized  deviations  from  the  conduct  which  sound  logic 
would  dictate.  Thus  it  is  a  familiar  fact,  well  discussed  by 
Adam  Smith,  that  men  will  readily  risk  a  small  amount  in 
the  hope  of  winning  a  large  when  the  adverse  probability 
(known  or  estimated)  against  winning  is  much  in  excess  of 


236  RISK,  UNCERTAINTY,  AND  PROFIT 

the  ratio  of  the  two  amounts,  while  they  commonly  will 
refuse  to  incur  a  small  chance  of  losing  a  larger  amount  for 
a  virtual  certainty  of  winning  a  smaller,  even  though  the 
actuarial  value  of  the  chance  is  in  their  favor.  To  this  bias 
must  be  added  an  inveterate  belief  on  the  part  of  the  typi- 
cal individual  in  his  own  "luck,"  especially  strong  when  the 
basis  of  the  uncertainty  is  the  quality  of  his  own  judgment. 
The  man  in  the  street  has  little  more  sense  of  the  real 
value  of  his  opinions  than  he  has  knowledge  of  the  "logic" 
(if  such  it  may  be  called)  on  which  they  rest.  In  addition, 
we  must  consider  the  almost  universal  prevalence  of  super- 
stitions. Any  coincidence  that  strikes  attention  is  likely 
to  be  elevated  into  a  law  of  nature,  giving  rise  to  a  belief 
in  an  unerring  "sign."  Even  a  mere  "hunch"  or  "some- 
thing tells  me,"  with  no  real  or  imaginary  basis  in  the 
mind  of  the  person  himself,  may  readily  be  accepted  as 
valid  ground  for  action  and  treated  as  an  unquestionable 
verity. 
/^j{  I  Doubtless  in  the  long  run  of  history  there  is  a  tendency 
*  toward  rationality  even  in  men's  whims  and  impulses.  And 
if  for  no  other  reason  than  the  impossibility  of  intelligently 
dealing  with  conduct  on  any  other  hypothesis,  we  seem 
justified  in  limiting  our  discussion  to  rational  grounds  of 
action.  We  shall  assume,  then,  that  if  a  man  is  undergoing 
a  sacrifice  for  the  sake  of  a  future  benefit,  the  expected  re- 
ward must  be  larger  in  order  to  evoke  the  sacrifice  if  it  is 
viewed  as  contingent  than  if  it  is  considered  certain,  and 
that  it  will  have  to  be  larger  in  at  least  some  general  pro- 
portion to  the  degree  of  felt  uncertainty  in  the  anticipa- 
tion.1   It  is  clearly  the  subjective  uncertainty  which  is 

1  The  chief  limitation  in  fact  relates  less  to  the  proposition  as  stated 
than  to  the  dogma  of  "conduct"  or  activity  exclusively  in  order  to  a 
future  reward.  Means  and  end  seem  to  be  the  form  in  which  we  think 
about  our  behavior  rather  than  the  actual  form  of  the  behavior  itself. 
The  literature  of  ethics  is  one  long  record  of  failure  to  find  any  absolute 
end;  in  life  every  end  becomes  a  means  to  some  new  and  farther  goal.  The 
attempt  to  rationalize  human  behavior  seems  to  be  a  perpetual  chase 


METHODS  FOR  MEETING  UNCERTAINTY     237 

decisive  in  such  a  case,  what  the  man  believes  the  chances 
to  be,  whether  his  degree  of  confidence  is  based  upon  an 
objective  probability  in  the  situation  itself  or  in  an  esti- 
mate of  his  own  powers  of  prediction.  We  hold  also  that 
both  the  objective  and  subjective  types  may  be  involved 
at  the  same  time,  though  no  doubt  most  men  do  not  carry 
their  deliberations  so  far;  the  man's  opinion  or  prediction 
may  be  an  estimate  of  an  obj'ective  probability,  and  the 
estimate  itself  be  recognized  as  having  a  certain  degree  of 
validity,  so  that  the  degree  of  felt  uncertainty  is  a  product 
of  two  probability  ratios.  It  is  to  be  emphasized  again 
that  practically  all  decisions  as  to  conduct  in  real  life  rest 
upon  opinions,  and  doubtless  the  greater  part  rest  upon 
opinions  which  on  scrutiny  easily  resolve  themselves  into 
an  opinion  of  a  probability  —  though  as  noted  this  "scru- 
tiny" may  not  in  most  cases  be  given  to  the  judgment 
by  the  individual  making  it. 

The  normal  economic  situation  is  of  this  character: 
The  adventurer  has  an  opinion  as  to  the  outcome,  within 
more  or  less  narrow  limits.  If  he  is  inclined  to  make  the 
venture,  this  opinion  is  either  an  expectation  of  a  certain 
definite  gain  or  a  belief  in  the  real  probability  of  a  larger 
one.  Outside  the  limits  of  the  anticipation  any  other  re- 
sult becomes  more  and  more  improbable  in  his  mind  as  the 
amount  thought  of  diverges  either  way.  Hence  it  is  cor-  _^ 
rect  to  treat  all  instances  of  economic  uncertainty  as  cases 
of  choice  between  a  smaller  reward  more  confidently  and  a 
larger  one  less  confidently  anticipated. 

At  the  bottom  of  the  uncertaintyproblem  in  economics 

is  the  forward-looking  character  of  the  economic  process 

itself.  Goods  are  produced  to  satisfy  wants;  the  production 

of  goods  requires  time,  and  two  elements  of  uncertainty 

after  one's  own  shadow,  and  the  conclusion  forces  itself  upon  us  that  the 
"summum  bonum"  or  any  other  objective  "bonum"  is  an  ignis  jatuus. 
We  are  compelled  to  believe  that  in  a  great  proportion  of  cases  we  take 
more  interest  in  action  whose  fruition  is  only  probable  than  we  would  if 
it  were  certain. 


238  RISK,  UNCERTAINTY,  AND  PROFIT 

are  introduced,  corresponding  to  two  different  kinds  of  fore- 
sight which  must  be  exercised.  First,  the  end  of  productive 
operations  must  be  estimated  from  the  beginning.  It  is 
notoriously  impossible  to  tell  accurately  when  entering 
upon  productive  activity  what  will  be  its  results  in  physi- 
cal terms,  what  (a)  quantities  and  (b)  qualities  of  goods 
will  result  from  the  expenditure  of  given  resources.  Second, 
the  wants  which  the  goods  are  to  satisfy  are  also,  of  course, 
in  the  future  to  the  same  extent,  and  their  prediction  in- 
volves uncertainty  in  the  same  way.  The  producer,  then, 
must  estimate  (1)  the  future  demand  which  he  is  striving 
to  satisfy  and  (2)  the  future  results  of  his  operations  in 
attempting  to  satisfy  that  demand. 

It  goes  without  saying  that  rational  conduct  strives  to 
reduce  to  a  minimum  the  uncertainties  involved  in  adapt- 
ing means  to  ends.  This  does  not  mean,  be  it  emphasized, 
that  uncertainty  as  such  is  abhorrent  to  the  human  species, 
which  probably  is  not  true.  We  should  not  really  prefer 
to  live  in  a  world  where  everything  was  "cut  and  dried," 
which  is  merely  to  say  that  we  should  not  want  our  activity 
to  be  all  perfectly  rational.  But  in  attempting  to. act  "in- 
telligently" we  are  attempting  to  secure  adaptation,  which 
means  foresight,  as  perfect  as  possible.  There  is,  as  already 
noted,  an  element  of  paradox  in  conduct  which  is  not  to 
be  ignored.  We  find  ourselves  compelled  to  strive  after 
things  which  in  a  "calm,  cool  hour"  we  admit  we  do  not 
want,  at  least  not  in  fullness  and  perfection.  Perhaps  it  is 
the  manifest  impossibility  of  reaching  the  end  which  makes 
it  interesting  to  strive  after  it.  In  any  case  we  do  strive  to 
reduce  uncertainty,  even  though  we  should  not  want  it 
eliminated  from  our  lives. 

The  possibility  of  reducing  uncertainty  depends  again 

on  two  fundamental  sets  of  conditions :  First,  uncertainties 

ii  —  *  —  L 

are  less  in  groups  of  cases  than  in  single  instances.  In  the 
case  of  a  priori  probability  the  uncertainty  tends  to  dis- 
appear altogether,  as  the  group  increases  in  inclusiveness; 


METHODS  FOR  MEETING  UNCERTAINTY      239 

with  statistical  probabilities  the  same  tendency  is  manifest 
in  a  less  degree,  being  limited  by  defectiveness  of  classifica- 
tion. And  even  the  third  type,  true  uncertainties,  show 
some  tendency  toward  regularity  when  grouped  on  the  basis 
of  nearly  any  similarity  or  common  element.  The  second 
fact  or  set  of  facts  making  for  a  reduction  of  uncertainty  is 
the  differences  among  human  individuals  in  regard  to  it. 
These  differences  are  of  many  kinds  and  an  enumeration  of 
them  will  be  undertaken  presently.  We  may  note  here 
that  they  may  be  differences  in  the  men  themselves  or 
differences  in  their  position  in  relation  to  the  problem.  We 
may  call  the  two  fundamental  methods  of  dealing  with 
uncertainty^  based  respectively  upon  reduction  by  group- 
ing and  upon  selection  of  men  to  "bear"  it,  "consolida- 
tion" *  fi^gfe^peciahzation,"  respectively.  To  these  two 
methods  wcTmust  add  two  others  which  are  so  obvious  as 
hardly  to  call  for  discussion :  (3)  control  of  the  future,  and 
(4)  increased  power  of  prediction.  These  are  closely  inter- 
related, since  the  chief  practical  significance  of  knowledge 
is  control,  and  both  are  clo0!ly  identified  with  the  general 
progress  of  civilization,  the  improvement  of  technology 
and  the  increase  of  knowledge.  Possibly  a  fifth  method 
should  be  named,  tH&^diffusion "  of  the  consequences  of 
untoward  contingencies.  Ofther  things  equal,  it  is  a  gain 
to  have  an  event  cause  a  loss  of  a  thousand  dollars  each  to  a 
hundred  persons  rather  than  a  hundred  thousand  to  one 
person;  it  is  better  for  two/men  to  lose  one  eye  than  for  one 
to  lose  two,  and  a  syste^of  production  which  wounds  a 
larger  number  of  workers  and  kills  a  smaller  nnmhpr  fc  t.n 
be  regarded  as  an  improvement.  In  practice  this  diffusion 
is  perhaps  always  associated  with  consolidation,  buFthere 
is  a  logical  distinction  between  the  two  and  they  may  be 
practically  separable  in  some  cases.  We  must  observe  also 

1  Professor  Irving  Fisher's  term  {The  Nature  of  Capital  and  Income, 
p.  288).  I  should  prefer  simply  "grouping"  as  both  shorter  and  more 
descriptive. 


240  RISK,  UNCERTAINTY,  AND  PROFIT 

that  consolidation  and  specialization  are  intimately  con- 
nected, a  fact  which  will  call  for  repeated  emphasis  as  we 
proceed.  In  addition  to  these  methods  of  dealing  with  un- 
certainty there  is  (6)  the  possibility  of  directing  industrial 
activity  more  or  less  along  lines  in  which  a  minimal  amount 
of  uncertainty  is  involved  and  avoiding  those  involving  a 
greater  degree. 

One  of  the  most  immediate  and  most  important  conse- 
quences of  uncertainty  in  economics  may  be  disposed  of  as 
a  preliminary  to  a  detailed  technical  discussion.  The  es- 
sence of  organized  economic  activity  is  the  production  by 
certain  persons  of  goods  which  will  be  used  to  satisfy  the 
wants  of  other  persons.  The  first  question  which  arises 
then  is,  which  of  these  groups  in  any  particular  case,  pro- 
ducers or  consumers,  shall  do  the  foreseeing  as  to  the  future 
wants  to  be  satisfied.  It  is  perhaps  obvious  that  the  func- 
tion of  prediction  in  the  technological  side  of  production 
itself  inevitably  devolves  upon  the  producer.  At  first  sight 
it  would  appear  that  the  consumer  should  be  in  a  better 
position  to  anticipate  his  own  wants  than  the  producer  to 
anticipate  them  for  him,  but  we  notice  at  once  that  this  is 
not  what  takes  place.  The  primary  phase  of  economic  or- 
ganization is  the  production  of  goods  for  a  general  market, 
not  upon  direct  order  of  the  consumer.  With  uncertainty 
absent  it  would  be  immaterial  whether  the  exchange  of 
goods  preceded  or  followed  actual  production.  With  un- 
certainty (in  the  two  fields,  production  and  wants)  present 
it  is  still  conceivable  that  men  might  exchange  productive 
services  instead  of  products,  but  the  fact  of  uncertainty 
operates  to  bring  about  a  different  result.  LTo  begin  with, 
modern  society  is  organized  on  the  theory  (whatever  the 
facts,  about  which  some  dOUbt  may  be  expressed)  that 
men  predict  the  future  and  adapt  their  conduct  to  jt  more 
effectively  when  the  results  accrue  to  themselves  than 
when  j£ey  accrue  to  othersj  The  responsibilities  of  con- 
trolling production  thus  devolve  upon  the  producer. 


METHODS  FOR  MEETING  UNCERTAINTY      241 

But  the  consumer  does  not  even  contract  for  his  goods  in 
advance,  generally  speaking.  A  part  of  the  reason  might 
be  the  consumer's  uncertainty  as  to  his  ability  to  pay  at 
the  end  of  the  period,  but  this  does  not  seem  to  be  impor- 
tant in  fact.  The  main  reason  is  that  he  does  not  know 
what  he  will  want,  and  how  much,  and  how  badly;  conse- 
quently he  leaves  it  to  producers  to  create  goods  and  hold 
them  ready  for  his  decision  when  the  time  comes.  The  clue 
to  the  apparent  paradox  is,  of  course,  in  the  "law  of  large 
numbers,"  the  consolidation  of  risks  (or  uncertainties). 
The  consumer  is,  to  himself,  only  one ;  to  the  producer  he  is  a 
mere  multitude  in  which  individuality  is  lost.  It  turns  out 
that  an  outsider  can  foresee  the  wants  of  a  multitude  with 
more  ease  and  accuracy  than  an  individual  can  attain  with 
respect  to  his  own.  ]  This  phenomenon  gives  us  the  most 
fundamental  feature  of  the  economic  system,  production 
for  a  market,  and  hence  also  the  general  character  of  the 
environment  in  relation  to  which  the  effects  of  uncertainty 
are  to  be  further  investigated.  Before  continuing  the  in- 
quiry into  other  phases  and  methods  of  the  consolidation 
of  risks,  we  shall  turn  briefly  to  consider  the  differences 
among  individuals  in  their  attitudes  and  reactions  toward 
measurable  or  unmeasurable  uncertainty. 

We  assume,  as  already  observed,  that  although  life  is  no 
doubt  more  interesting  when  conduct  involves  a  certain 
amount  of  uncertainty,  —  the  proper  amount  varying  with 
individuals  and  circumstances,  —  yet  that  men  do  actually 
strive  to  anticipate  the  future  accurately  and  adapt  their 
conduct  to  it.  In  this  respect  we  may  distinguish  at  least 
five  variable  elements  in  individual  attributes  and  capaci- 
ties^ tt)  Men  differ  in  their  capacity  by  perception  and 
inference  to  form  correct  judgments  as  to  the  future  course 
of  events  in  the  environment.  This  capacity,  furthermore, 
is  far  from  homogeneous,  some  persons  excelling  in  fore- 
sight in  one  kind  of  problem  situations,  others  in  other 
kinds,  in  almost  endless  variety.   Of  especial  importance 


242  RISK,  UNCERTAINTY,  AND  PROFIT 

is  the  variation  in  the  power  of  reading  human  nature,  of 
forecasting  the  conduct  of  other  men,  as  contrasted  with 
scientific  judgment  in  regard  to  natural  phenomena.  (2) 
Another,  though  related,  difference  is  found  in  men's  ca- 
pacities  to  judge  means  and  discern  and  plan  the  steps 
and  adjustments  necessary  to  meet  the  anticipated  future 
situation.  (3)  There  is  a  similar  variation  in  the  power  to 
execute  the  plans  and  adjustments  believed  to  be  requisite 
and  desirable.  (4)  In  addition  there  is  diversity  in  conduct 
in  situations  involving  uncertainty  due  to  differences  in 
the"  "amount  of  confidence  which  individuals  feel  in  their 
judgments  when  formed  and  in  their  powers  of  execution; 
this  degree  of  confidence  is  in  large  measure  independent 
of  the  "true  value"  of  the  judgments  and  powers  them- 
selves. (5)  Distinct  from  confidence  felt  is  the  conative 
attitude ±Qj3i  situation  upon  which  judgment  is  passed  with 
a  given  degree  of  confidence.  It  is  a  familiar  fact  that  some 
individuals  want  to  be  sure  and  will  hardly  "take  chances " 
at  all,  while  others  like  to  work  on  original  hypotheses  and 
seem  to  prefer  rather  than  to  shun  uncertainty.  It  is 
common  to  see  people  act  on  assumptions  in  ways  which 
their  own  opinions  of  the  value  of  the  assumption  do  not 
warrant;  there  is  a  disposition  to  "trust  in  one's  luck." 

The  amount  of  uncertainty  effective  in  a  conduct  situa- 
tion is  the  degree  of  subjective  confidence  felt  in  the  contem- 
plated act  as  a  correct  adaptation  to  the  future  —  number 
4  above.  It  is  clear  that  we  may  speak  in  some  sense  of  the 
"true  value"  of  judgment  and  of  capacity  to  act,  but  it  is 
the  person's  own  opinion  of  these  values  which  controls  his 
activities.  Hence  the  five  variables  are,  from  the  standpoint 
of  the  person  concerned,  reduced  ro  two v  the  (subjective 
or  felt )  uncertainty  and  his  conative  feeling  toward  it.  For 
completeness  we  should  perhaps  add  a  sixth  uncertainty 
factor,  in  the  shape  of  occurrences  so  revolutionary  and  un- 
expected by  any  one  as  hardly  to  be  brought  under  the 
category  of  an  error  in  judgment  at  all. 


METHODS  FOR  MEETING  UNCERTAINTY     243 

In  addition  to  the  above  enumeration  of  five  or  six  dis- 
tinct elements  in  the  uncertainty  situation  we  must  point 
out  that  the  first  three  variables  named  are  themselves  not 
simple.  Judgment  or  foresight  and  the  capacity  for  plan- 
ning and  the  ability  to  execute  action  are  each  the  prod- 
uct of  at  least  four  distinguishable  factors,  in  regard  to 
which  the  faculties  in  question  may  vary  independently. 
These  are  (a)  accuracy,  fh)  promptness  or  speed  J  (c)  Jime 
range,  and  (d)  space  rangeJ  of  the  capacity  or  action.  The 
first  two  of  these  require  no  explanation;  it  is  evident  that 
accuracy  and  rapidity  of  judgment  and  execution  are  more 
or  less  independent  endowments.  The  third  refers  to  the 
length  of  time  in  the  future  to  which  conduct  is  or  may  be 
adjusted,  and  the  fourth  to  the  scope  or  magnitude  of  the 
situation  envisaged  and  the  operations  planned.  Familiar 
also  is  the  difference  between  individuals  who  have  a  mind 
for  detail  and  those  who  confine  their  attention  to  the 
larger  outlines  of  a  situation.  Even  this  rather  complex 
outline  is  extremely  simplified  as  compared  with  the  facts  of 
life  in  that  it  compasses  only  a  rigidly  "static"  view  of  the 
problem.  Quite  as  important  as  differences  obtaining  at 
any  moment  among  individuals  in  regard  to  the  attributes 
mentioned  are  their  differences  in  capacity  for  change  or 
development  along  the  various  lines.  Knowledge  is  more  a 
matter  of  learning  than  of  the  exercise  of  absolute  judg- 
ment. Learning  requires  time,  and  in  time  the  situation 
dealt  with,  as  well  as  the  learner,  undergoes  change. 

We  have  classified  the  possible  reactions  t.o  nnrarta.int.y 
under  some  half-dozenjieads,  each  of  which  gives  rise  to 
special  problems,  though  the  social  structures  for  dealing 
with  these  problems  overlap  a  good  deal.  The  most  funda- 
mental facts  regarding  uncertainty  from  our  point  of  view 
are,  first,  the  possibility  of  reducing  it  in  amount  by  group- 
ing instances;  and,  second,  the  differences  in  individuals  in 
relation  to  uncertainty,  giving  rise  to  a  tendency  to  spe- 
cialize the  function  of  meeting  it  in  the  hands  of  certain 


244  RISK,  UNCERTAINTY,  AND  PROFIT 

individuals  and  classes.  The  most  fundamental  effect  of 
uncertainty  on  the  social-economic  organization  —  produc- 
tion for  a  general  market  on  the  producer's  responsibility 
—  has  already  been  taken  up;  it  is  primarily  a  case  of  re- 
duction of  uncertainty  by  consolidation  or  grouping  of  cases. 
In  the  mere  fact  of  production  for  a  market,  there  is  little 
specialization  of  uncertainty-bearing,  and  what  there  is  is 
on  a  basis  of  the  producer's  position  in  relation  to  the  prob- 
lem, not  his  peculiar  characteristics  as  a  man.  To  isolate 
the  phenomenon  of  production  for  a  market  from  other 
considerations  we  must  picture  a  pure  "handicraft  stage" 
of  social  organization.  In  such  a  system  every  individual 
would  be  an  independent  producer  of  some  one  finished 
commodity,  and  a  consumer  of  a  great  variety  of  products. 
The  late  Middle  Ages  afford  a  picture  of  an  approxima- 
tion to  such  a  state  of  affairs  in  a  part  of  the  industrial 
field. 

The  approximation  is  rather  remote,  however.  A  handi- 
craft organization  shows  an  irresistible  tendency  to  pass 
over,  even  before  well  established,  into  a  very  different 
system,  and  this  further  development  is  also  a  consequence 
of  the  presence  of  uncertainty.  The  second  system  is  that 
of  "free  enterprise"  which  we  find  dominant  to-day.  The 
difference  between  free  enterprise  and  mere  production  for 
a  market  represents  the  addition  of  specialization  of  un- 
certainty-bearing to  the  grouping  of  uncertainties,  and 
takes  place  under  pressure  of  the  same  problem,  the  antici- 
pation of  wants  and  control  of  production  with  reference 
to  the  future.  Under  free  enterprise  the  solution  of  this 
problem,  already  removed  from  the  consumer  himself,  is 
further  taken  out  of  the  hands  of  the  great  mass  of  produc- 
ers as  well  and  placed  in  charge  of  a  limited  class  of  "entre- 
preneurs" or  "business  men."  The  bulk  of  the  producing 
population  cease  to  exercise  responsible  control  over  pro- 
duction and  take  up  the  subsidiary  role  of  furnishing  pro- 
ductive resources  (labor,  land,  and  capital)  to  the  entre- 


METHODS  FOR  MEETING  UNCERTAINTY     245 

preneur,  placing  them  under  his  sole  direction  for  a  fixed 
contract  price. 

We  shall  take  up  this  phenomenon  of  free  enterprise  for 
detailed  discussion  in  the  next  chapter,  though  we  may 
note  here  two  further  facts  regarding  it;  first,  the  "spe- 
cialization "  of  uncertainty-bearing  in  the  hands  of  entre- 
preneurs involves  also  a  further  consolidation;  and,  second, 
it  is  closely  connected  with  changes  in  technological  meth- 
ods which  (a)  increase  the  time  length  of  the  production 
process  and  correspondingly  increase  the  uncertainty  in- 
volved, and  (b)  form  producers  into  large  groups  working 
together  in  a  single  establishment  or  productive  enterprise 
and  hence  necessitates  concentration  of  control.  The  re- 
mainder of  the  present  chapter  will  be  devoted  to  a  survey 
of  the  social  structures  evolved  for  dealing  with  uncertainty. 
Some  of  the  phenomena  will  thus  be  finally  disposed  of, 
so  far  as  the  present  work  is  concerned,  especially  those 
which  already  have  a  literature  of  their  own  and  whose 
general  bearings  and  place  in  a  systematic  treatment  of 
uncertainty  alone  call  for  notice  here.  Other  problems  will 
be  merely  sketched  in  outline  and  reserved  for  fuller  treat- 
ment in  subsequent  chapters,  as  has  just  been  done  with 
the  subject  of  entrepreneurship. 

Following  the  order  of  the  classification  already  given  of 
methods  of  dealing  with  uncertainty,  the  first  subject  for 
discussion  is  the  institutions  or  special  phenomena  arising 
from  the  tendency  to  deal  with  uncertainty  by  consolida- 
tion. The  most  obvious  and  best  known  of  these  devices  is, 
of  course,  insurance,  which  has  already  been  repeatedly  used 
as  an  illustration  of  the  principle  of  eliminating  uncertainty 
by  dealing  with  groups  of  cases  instead  of  individual  cases. 
In  our  discussion  of  the  theory  of  uncertainty  in  the  forego- 
ing chapter  and  at  other  points  in  the  study  we  have  em- 
phasized the  radical  difference  between  a  measurable  and 
an  unmeasurable  uncertainty.  Now  measurability  depends 
on  the  possibility  of  assimilating  a  given  situation  to  a 


246  RISK,  UNCERTAINTY,  AND  PROFIT 

group  of  similars  and  finding  the  proportions  of  the  mem- 
bers of  the  group  which  may  be  expected  to  exhibit  the 
various  possible  outcomes.  This  assimilation  of  cases  into 
classes  may  be  exceedingly  accurate,  and  the  proportions 
of  the  various  outcomes  may  be  computable  on  a  priori 
grounds  by  the  application  of  the  theory  of  permutations 
and  combinations  to  determine  the  possible  groupings  of 
equally  probable  alternatives;  but  this  rarely  if  ever  happens 
in  a  practical  business  situation.  The  classification  will  be 
of  all  degrees  of  precision,  but  the  ascertainment  of  pro- 
portions must  be  empirical.  The  application  of  the  in- 
surance principle,  converting  a  larger  contingent  loss  into  a 
smaller  fixed  charge,  depends  upon  the  measurement  of 
probability  on  the  basis  of  a  fairly  accurate  grouping  into 
classes.  It  is  in  general  not  enough  that  the  insurer  who 
takes  the  "risk"  of  a  large  number  of  cases  be  able  to  pre- 
dict his  aggregate  losses  with  sufficient  accuracy  to  quote 
premiums  which  will  keep  his  business  solvent  while  at  the 
same  time  imposing  a  burden  on  the  insurer  which  is  not 
too  large  a  fraction  of  his  contingent  loss.  In  addition  he 
must  be  able  to  present  a  fairly  plausible  contention  that 
the  particular  insured  is  contributing  to  the  total  fund  out 
of  which  losses  are  paid  as  they  accrue  in  an  amount  corre- 
sponding reasonably  well  with  his  real  probability  of  loss; 
i.e.,  that  he  is  bearing  his  fair  share  of  the  burden. 

The  difficulty  of  a  satisfactory  logical  discussion  of  the 
questions  we  are  dealing  with  has  repeatedly  been  em- 
phasized, due  to  the  fact  that  distinctions  of  the  greatest 
importance  tend  to  run  together  through  intermediate 
degrees  and  become  blurred.  This  is  conspicuously  the  case 
with  the  measurability  of  uncertainty  through  classifica- 
tion of  instances.  We  hardly  find  in  practice  really  homo- 
geneous classifications  (in  the  sense  in  which  mathematical 
probability  implies,  as  in  the  case  of  successive  throws  of  a 
perfect  die)  and  at  the  other  extreme  it  is  hard  to  find  cases 
which  do  not  admit  of  some  possibility  of  assimilation  into 


of   i 

es 
of 


METHODS  FOR  MEETING  UNCERTAINTY     247 

groups  and  hence  of  measurement.  Indeed,  the  very  con- 
cept of  contingency  seems  to  preclude  absolute  uniqueness 
(as  for  that  matter  there  is  doubtless  nothing  absolutely 
unique  in  the  universe).  For  to  say  that  a  certain  event  is 
contingent  or  "possible"  or  "may  happen"  appears  to  be 
equivalent  to  saying  that  "such  things  "  have  been  known  to 
happen  before,  and  the  "such  things"  manifestly  consti- 
tute a  class  of  cases  formed  on  some  ground  or  other.  The 
principal  subject  for  investigation  is  thus  the  degree  of 
assimilability,  or  the  amount  of  homogeneity  of  classes 
securable,  or,  stated  inversely,  the  degree  of  uniqueness 
various  kinds  of  business  contingencies.  Insurance  deals 
with  those  which  are  "fairly"  classifiable' or  show  a  rela- 
tively low  degree  of  uniqueness,  but  the  different  branches 
of  insurance  show  a  wide  range  of  variation  in  the  accuracy 
of  measurement  of  probability  which  they  secure. 

Before  taking  up  various  types  of  insurance  we  may  note 
in  passing  a  point  which  it  is  superfluous  to  elaborate  in 
this  connection,  namely,  that  different  forms  of  organiza- 
tion in  the  insurance  field  all  operate  on  the  same  principle. 
It  matters  not  at  all  whether  the  persons  liable  to  a  given 
contingency  organize  among  themselves  into  a  fraternal  or 
mutual  society  or  whether  they  separately  contract  with 
an  outside  party  to  bear  their  losses  as  they  fall  in.  Under 
competitive  conditions  and  assuming  that  the  probabilities 
involved  are  accurately  known,  an  outside  insurer  will  make 
no  clear  profit  and  the  premiums  will  under  either  sys- 
tem be  equal  to  the  administrative  costs  of  carrying  on  the 
business. 

The  branch  of  insurance  which  is  most  highly  developed, 
meaning  that  its  contingencies  are  most  accurately  meas- 
ured because  its  classifications  are  most  perfect,  and  which 
is  thus  on  the  most  nearly  "mathematical"  basis  is,  of 
course,  what  is  called  "life  insurance."  (In  so  far  as  it  is 
"insurance"  at  all,  and  not  a  mere  investment  proposition, 
it  is  clear  that  it  is  insurance  against  "premature"  loss  of 


248  RISK,  UNCERTAINTY,  AND  PROFIT 

earning  power,  and  not  against  death.)  It  is  possible,  on 
the  basis  of  medical  examinations,  and  taking  into  account 
age,  sex,  place  of  residence,  occupation,  and  habits  of  life, 
to  select  "risks"  which  closely  approximate  the  ideal  of 
mechanical  probability.  The  chance  of  death  of  two 
healthy  individuals  similarly  circumstanced  in  the  above 
regards  seems  to  be  about  as  near  an  objective  equality, 
the  life  or  death  of  one  rather  than  the  other  about  as  nearly 
really  indeterminate,  as  anything  in  nature.  To  be  sure, 
when  we  pass  outside  the  relatively  narrow  circle  of  "nor- 
mal" individuals,  difficulties  are  encountered,  but  the  ex- 
tension of  life  insurance  outside  this  circle  has  also  been 
restricted.  Some  development  has  taken  place  in  the  insur- 
ance of  sub-standard  lives  at  higher  rates,  but  it  is  limited 
in  amount  and  could  be  characterized  as  exceptional.1 

The  very  opposite  situation  from  life  insurance  is  found 
in  insurance  against  sickness  and  accident.  Here  an  ob- 
jective description  and  classification  of  cases  is  impossible, 
the  business  is  fraught  with  great  difficulties  and  suscepti- 
ble of  only  a  limited  development.  It  is  notorious  that  such 
policies  cost  vastly  more  than  they  should;  indeed,  the 
companies  find  it  profitable  to  adopt  a  generous  attitude  in 
the  adjustment  of  claims,  raising  the  premium  rates  ac- 
cordingly, it  is  needless  to  say.  Accident  compensation  for 
workkigmen,  under  social  control,  is  on  a  somewhat  better 
footing,  but  only  on  condition  that  the  payments  are  re- 

1  It  would  be  out  of  place  here  to  go  into  the  social  aspects  of  life  in- 
surance, but  one  observation  may  be  worth  making.  From  the  social 
point  of  view  it  is  arguable  that  all  classification  of  risks  is  a  bad  thing, 
except  in  so  far  as  the  special  hazard  is  purely  occupational  and  the  cost 
of  carrying  it  can  be  transferred  to  the  consumer  of  the  product.  It  is 
hard  to  discover  any  good  reason  why  the  unfortunate  should  be  especially 
burdened  because  of  their  handicaps.  It  would,  therefore,  be  better  if  all 
were  insured  at  a  uniform  rate.  Indeed,  we  may  go  farther  and  contend 
that  the  rate  should  be  graduated  inversely  with  the  risk  (occupational 
risks  excepted,  as  noted).  It  goes  without  saying  that  only  a  state  com- 
pulsory insurance  scheme  could  operate  on  any  such  principles;  under 
private  profit  incentives,  competition  will  compel  any  insurance  agency  to 
classify  its  risks  as  accurately  and  minutely  as  practicable. 


METHODS  FOR  MEETING  UNCERTAINTY      249 

stricted  to  not  too  large  a  fraction  of  the  actual  economic 
loss  to  the  individual,  with  nothing  for  discomfort,  pain,  or 
inconvenience.  In  the  whole  field  of  personal,  physical  con- 
tingencies, however,  there  is  nothing  that  is  strictly  of  the 
nature  of  a  "business  risk,"  unless  it  be  the  now  happily 
obsolescent  phenomenon  of  commercial  employers'  liability 
insurance. 

The  typical  application  of  insurance  to  business  hazards 
is  in  the  protection  against  loss  by  fire,  and  the  theory  of 
fire  insurance  rates  forms  an  interesting  contrast  with  the 
actuarial  mathematics  of  life  insurance.  The  latter,  as  we 
have  observed,  is  a  fairly  close  approximation  to  objective 
probability;  it  is  in  fact  so  close  to  this  ideal  that  life  in- 
surance problems  are  worked  by  the  formulae  derived  from 
the  binomial  law,  in  the  same  way  as  problems  in  mechan- 
ical probability.  Fire  insurance  rating  is  a  very  different 
proposition;  only  in  rather  recent  years  has  any  approach 
been  made  to  the  formation  of  fairly  homogeneous  classes 
of  risks  and  the  measurement  of  real  probability  in  a  par- 
ticular case.  At  best  there  is  a  large  field  for  the  exercise 
of  "judgment"  even  after  literally  thousands  of  classes  of 
risks  have  been  more  or  less  accurately  defined.1  More  im- 
portant is  the  fact  that,  in  consequence,  insurance  does  not 
take  care  of  the  whole  risk  against  loss  by  fire.  On  account 
of  the  "moral  hazard"  and  practical  difficulties,  it  is  nec- 
essary to  restrict  the  amount  of  insurance  to  the  "direct 
loss  or  damage"  or  even  to  a  part  of  that,  while  of  course 
there  are  usually  large  indirect  losses  due  to  the  interrup- 
tion of  business  and  dislocation  of  business  plans  which  are 
entirely  unprovided  for.  Thus  there  is  a  large  margin  of 
uncertainty  both  to  insurer  and  insured,  in  consequence 
of  the  impossibility  of  objectively  homogeneous  groupings 
and  accurate  measurement  of  the  chance  of  loss.  Corre- 
sponding to  this  margin  of  uncertainty  in  the  calculations 
there  is  a  chance  for  a  profit  or  loss  to  either  party,  in 
1  Cf.  Huebner,  Property  Insurance,  chaps,  xvr,  xvn. 


250  RISK,  UNCERTAINTY,  AND  PROFIT 

connection  with  the  fire  hazard.  The  probabilities  in  the 
case  of  fire  are,  of  course,  complicated  by  the  fact  that  risks 
are  not  entirely  independent.  A  fire  once  started  is  likely 
to  spread  and  there  is  a  tendency  for  losses  to  occur  in 
groups.  In  so  far,  however,  as  fire  losses  in  the  aggregate 
are  calculable  in  advance,  they  are  or  may  be  converted 
into  fixed  costs  by  every  individual  exposed  to  the  possi- 
bility of  loss,  and  in  so  far  no  profit,  positive  or  negative, 
will  be  realized  by  any  one  on  account  of  this  uncertainty 
in  his  business. 

The  principle  of  insurance  has  also  been  utilized  to  pro- 
vide against  a  great  variety  of  business  hazards  other  than 
fire  —  the  loss  of  ships  and  cargoes  at  sea,  destruction  of 
crops  by  storms,  theft  and  burglary,  embezzlement  by 
employees  (indirectly  through  bonding,  the  employee  do- 
ing the  insuring),  payment  of  damages  to  injured  em- 
ployees, excessive  losses  through  credit  extension,  etc. 
The  unusual  forms  of  policies  issued  by  some  of  the  Lloyd's 
underwriters  have  attained  a  certain  amount  of  publicity 
as  popular  curiosities.  These  various  types  of  contingencies 
offer  widely  divergent  possibilities  for  "scientific"  rate- 
making,  from  something  like  the  statistical  certainty  of 
life  insurance  at  one  extreme  to  almost  pure  guesswork  at 
the  other,  as  when  Lloyd's  insures  the  business  inter- 
ests concerned  that  a  royal  coronation  will  take  place  as 
scheduled,  or  guarantees  the  weather  in  some  place  having 
no  records  to  base  calculations  upon.  Even  in  these  ex- 
treme cases,  however,  there  is  a  certain  vague  grouping  of 
cases  on  the  basis  of  intuition  or  judgment;  only  in  this 
way  can  we  imagine  any  estimate  of  a  probability  being 
arrived  at. 

It  is  therefore  seen  that  the  insurance  principle  can  be 
\  applied  even  in  the  almost  complete  absence  of  scientific 
data  for  the  computation  of  rates.    If  the  estimates  are 
conservative  and  competent,  it  turns  out  that  the  pre- 
miums received  for  insuring  the  most  unique  contingen- 


METHODS  FOR  MEETING  UNCERTAINTY      251 

cies  cover  the  losses;  that  there  is  an  offsetting  of  losses  and 
gains  from  one  venture  to  another,  even  when  there  is  no 
discoverable  kinship  among  the  ventures  themselves.  The 
point  seems  to  be,  as  already  noticed,  that  the  mere  fact 
that  judgment  is  being  exercised  in  regard  to  the  situations 
forms  a  fairly  valid  basis  for  assimilating  them  into  groups. 
Various  instances  of  the  exercise  of  (fairly  competent) 
judgment  even  in  regard  to  the  most  heterogeneous  prob- 
lems, show  a  tendency  to  approach  a  constancy  and  pre- 
dictability of  result  when  aggregated  into  groups. 

The  fact  which  limits  the  application  of  the  insurance 
principle  to  business  risks  generally  is  not  therefore  their 
inherent  uniqueness  alone,  and  the  subject  calls  for  further 
examination.  This  task  will  be  undertaken  in  detail  in  the 
next  chapter,  which  deals  with  entrepreneurship.  At  this 
point  we  may  anticipate  to  the  extent  of  making  two 
observations:  first,  the  typical  uninsurable  (because  un- 
measurable  and  this  because  unclassifiable)  business  risk 
relates  to  the  exercise  of  judgment  in  the  making  of  de- 
cisions by  the  business  man;  second,  although  such  es- 
timates do  tend  to  fall  into  groups  within  which  fluctuations 
cancel  out  and  hence  to  approach  constancy  and  measur- 
ability,  this  happens  only  after  the  fact  and,  especially  in 
view  of  the  brevity  of  a  man's  active  life,  can  only  to  a 
limited  extent  be  made  the  basis  of  prediction.  Further- 
more, the  classification  or  grouping  can  only  to  a  limited 
extent  be  carried  out  by  any  agency  outside  the  person 
himself  who  makes  the  decisions,  because  of  the  peculiarly 
obstinate  connection  of  a  moral  hazard  with  this  sort  of 
risks.  The  decisive  factors  in  the  case  are  so  largely  on  the 
inside  of  the  person  making  the  decisions  that  the  "in- 
stances" are  not  amenable  to  objective  description  and 
external  control. 

Manifestly  these  difficulties,  insuperable  when  the 
" consolidation' '  is  to  be  carried  out  by  an  external  agency 
such  as  an  insurance  company  or  association,  fall  away  in 


252  RISK,  UNCERTAINTY,  AND  PROFIT 

so  far  as  consolidation  can  be  effected  within  the  scale  of 
operations  of  a  single  individual;  and  the  same  will  be  true 
of  an  organization  if  responsibility  can  be  adequately 
centralized  and  unity  of  interest  secured.  The  possibility  of 
thus  reducing  uncertainty  by  transforming  it  into  a  meas- 
urable risk  through  grouping  constitutes  a  strong  incentive 
to  extend  the  scale  of  operations  of  a  business  establishment. 
This  fact  must  constitute  one  of  the  important  causes  of  the 
)henomenal  growth  in  the  average  size  of  industrial  es- 
tablishments which  is  a  familiar  characteristic  of  modern 
economic  life.  In  so  far  as  a  single  business  man,  by  bor- 
rowing capital  or  otherwise,  can  extend  the  scope  of  his 
exercise  of  judgment  over  a  greater  number  of  decisions  or 
estimates,  there  is  a  greater  probability  that  bad  guesses 
will  be  offset  by  good  ones  and  that  a  degree  of  constancy 
and  dependability  in  the  total  results  will  be  achieved.  In 
so  far  uncertainty  is  eliminated  and  the  desideratum  of 
rational  activity  realized. 

Not  less  important  is  the  incentive  to  substitute  more 
effective  and  intimate  forms  of  association  for  insurance,  so 
as  to  eliminate  or  reduce  the  moral  hazard  and  make  possi- 
ble the  application  of  the  insurance  principle  of  consolida- 
tion to  groups  of  ventures  too  broad  in  scope  to  be  "  swung  " 
by  a  single  enterpriser.  Since  it  is  capital  which  is  especially 
at  risk  in  operations  based  on  opinions  and  estimates,  the 
form  of  organization  centers  around  the  provisions  relating 
to  capital.  It  is  undoubtedly  true  that  the  reduction  of 
risk  to  borrowed  capital  is  the  principal  desideratum  lead- 
ing to  the  displacement  of  individual  enterprise  by  the 
partnership  and  the  same  fact  with  reference  to  both 
owned  and  borrowed  capital  explains  the  substitution  of 
corporate  organization  for  the  partnership.  The  superior- 
ity of  the  higher  form  of  organization  over  the  lower  from 
this  point  of  view  consists  both  in  the  extension  of  the 
scope  of  operations  to  include  a  larger  number  of  indi- 
vidual  decisions,  ventures,  or   "instances,"  and  in  the 


METHODS  FOR  MEETING  UNCERTAINTY     253 

more  effective  unification  of  interest  which  reduces  the 
moral  hazard  connected  with  the  assumption  by  one  per- 
son of  the  consequences  of  another  person's  decisions. 

The  close  connection  between  these  two  considerations  is 
manifest.  It  is  the  special  "risk"  to  which  large  amounts 
of  capital  loaned  to  a  single  enterpriser  are  subject  which 
limits  the  scope  of  operations  of  this  form  of  business  unit 
by  making  it  impossible  to  secure  the  necessary  property 
resources.  On  the  other  hand,  it  is  the  inefficiency  of  or- 
ganization, the  failure  to  secure  effective  unity  of  interest, 
and  the  consequent  large  risk  due  to  moral  hazard  when  a 
partnership  grows  to  considerable  size,  which  in  turn  limit 
its  extension  to  still  larger  magnitudes  and  bring  about  the 
substitution  of  the  corporate  form  of  organization.  With 
the  growth  of  large  fortunes  it  becomes  possible  for  a 
limited  number  of  persons  to  carry  on  enterprises  of  greater 
and  greater  magnitude,  and  to-day  we  find  many  very 
large  businesses  organized  as  partnerships.  Modifications 
of  partnership  law  giving  this  form  more  of  the  flexibility 
of  the  corporation  with  reference  to  the  distribution  of 
rights  of  control,  of  participation  in  income,  and  of  title  to 
assets  in  case  of  dissolution  have  also  contributed  to  this 
change. 

With  reference  to  the  first  of  our  two  points  above  men- 
tioned, the  extension  of  the  scope  of  operations,  the  cor- 
poration may  be  said  to  have  solved  the  organization  prob- 
lem. There  appears  to  be  hardly  any  limit  to  the  magnitude 
of  enterprise  which  it  is  possible  to  organize  in  this  form,  so 
far  as  mere  ability  to  get  the  public  to  buy  the  securities  is 
concerned.  On  the  second  score,  however,  the  effective 
unification  of  interests,  though  the  corporation  has  ac- 
complished much  in  comparison  with  other  forms  of  organi- 
zation, there  is  still  much  to  be  desired.  Doubtless  the 
task  is  impossible,  in  any  absolute  sense;  nothing  but  a 
revolutionary  transformation  in  human  nature  itself  can 
apparently  solve  this  problem  finally,  and  such  a  change 


254  RISK,  UNCERTAINTY,  AND  PROFIT 

would,  of  course,  obliterate  all  moral  hazards  at  once,  with- 
out organization.  In  the  meanwhile  the  internal  problems 
of  the  corporation,  the  protection  of  its  various  types  of 
members  and  adherents  against  each  other's  predatory 
propensities,  are  quite  as  vital  as  the  external  problem  of 
safeguarding  the  public  interests  against  exploitation  by 
the  corporation  as  a  unit.1 

Another  important  aspect  of  the  relations  of  corporate 
organization  to  risk  involves  what  we  have  called  "diffu- 
sion" as  well  as  consolidation.  The  minute  divisibility 
of  ownership  and  ease  of  transfer  of  shares  enables  an 
investor  to  distribute  his  holdings  over  a  large  number  of 
enterprises  in  addition  to  increasing  the  size  of  a  single 
enterprise.  The  effect  of  this  distribution  on  risk  is  evi- 
dently twofold.  In  the  first  place,  there  is  to  the  investor  a 
further  offsetting  through  consolidation;  the  losses  and 
gains  in  different  corporations  in  which  he  owns  stock  must 
tend  to  cancel  out  in  large  measure  and  provide  a  higher 
degree  of  regularity  and  predictability  in  his  total  returns. 
And  again,  the  chance  of  loss  of  a  small  fraction  of  his 
total  resources  is  of  less  moment  even  proportionally  than 
a  chance  of  losing  a  larger  part. 

There  are  other  aspects  of  the  question  which  must  be 
passed  over  in  this  summary  view.  Doubtless  a  signifi- 
cant fact  is  the  greater  publicity  attendant  upon  the  or- 
ganization, resources,  and  operations  of  a  corporation, 
due  to  its  being  a  creature  of  the  State  and  to  legal  safe- 
guards. It  must  be  emphasized  that  this  type  of  organiza- 
tion actually  reduces  risks,  and  does  not  merely  transfer 
them  from  one  party  to  another,  as  might  seem  at  first 
glance  to  be  the  case.    Superficial  discussions  of  limited 

1  Haney  (Business  Organization  and  Combination,  chap,  xxm)  uses  the 
terms  "The  Corporation  Problem"  and  "The  Trust  Problem"  to  desig- 
nate what  I  have  called  the  "internal"  and  "external"  problems  respec- 
tively. He  properly  emphasizes  the  importance  of  the  former  in  view  of 
the  tendency  of  the  evils  of  monopoly,  etc.,  to  overshadow  it  in  the  pop- 
ular mind  and  in  much  of  the  literature  of  the  subject. 


METHODS  FOR  MEETING  UNCERTAINTY     255 

liability  tend  to  give  the  impression,  or  at  least  leave  the 
way  open  to  the  conclusion,  that  this  is  the  main  advantage 
over  the  partnership.  But  it  must  be  evident  that  the 
mere  fact  of  limited  liability  only  serves  to  transfer  losses 
in  excess  of  invested  resources  from  the  owners  of  the  con- 
cern to  its  creditors;  and  if  this  were  the  only  effect  of  in- 
corporation, the  loss  in  credit  standing  should  offset  the 
gain  in  security  to  the  owners.  Theyital  facts  are  the  two- 
fold consolidation  of  risks,  together  with  greater  publicity, 
and  diffusion  in  a  minor  role,  not  really  separable  from  the 
fact  of  consolidation. 

It  is  particularly  noteworthy  that  large-scale  organiza- 
tion has  shown  a  tendency  to  grow  in  fields  where  division 
of  labor  is  absent  and  consolidation  or  grouping  of  uncer- 
tainties is  the  principal  incentive.  Occupations  in  which 
the  work  is  of  an  occasional  and  intermittent  character 
tend  to  run  into  partnerships  and  even  corporations  where 
there  is  no  capital  investment,  or  relatively  little,  and  the 
members  work  independently  at  identical  tasks.  Examples 
are  the  syndicating  of  detectives,  stenographers,  and  even 
lawyers  and  doctors. 

The  second  of  the  two  main  principles  for  dealing  with 
uncertainty  is  Specialization.  The  most  important  in- 
strument in  modern  economic  society  for  the  specializa- 
tion of  uncertainty,  after  the  institution  of  free  enterprise 
itself,  is  Speculation.  This  phenomenon  also  combines 
different  principles,  and  the  n?^  speriahVati™1  ^  Uftte* 
tainty-bearinff  in  the  ha^g  dt  perftp"*  moat,  willing  to  as- 
sume the  function  is  probably  among  the  lesser  rather  than 
the  greater  sources  of  gain.  It  seems  best  to  postpone  for 
the  present  a  detailecTtneoretical  analysis  of  the  factors 
of  specialization  of  uncertainty-bearing  in  the  light  of  the 
many  ways  in  which  individuals  differ  in  their  relations  to 
uncertainty;  this  discussion  will  be  taken  up  in  the  next 
chapter,  in  connection  with  the  treatment  of  enterprise  and 
entrepreneurship.   At  this  point  we  wish  merely  to  em- 


D 


\ 


256  RISK,  UNCERTAINTY,  AND  PROFIT 

phasize  the  association  in  several  ways  between  specializa- 
tion and  actual  reduction  of  uncertainty. 

Most  fundamental  among  these  effects  in  reducing  un- 
certainty  is  its  conversion  into  a  measured  risk  or  elimina- 
tion by  grouping  which  is  implied  in  the  very  fact  of  special- 
ization. The  typical  illustration  to  show  the  advantage  of 
organized  speculation  to  business  at  large  is  the  use  of  the 
hedging  contract.  By  this  simple  device  the  industrial 
producer  is  enabled  to  eliminate  the  chance  of  loss  or  gain 
due  to  changes  in  the  value  of  materials  used  in  his  opera- 
tions during  the  interval  between  the  time  he  purchases 
them  as  raw  materials  and  the  time  he  disposes  of  them  as 
finished  product,  "shifting"  this  risk  to  the  professional 
speculator.  It  is  manifest  at  once  that  even  aside  from 
any  superior  judgment  or  foresight  or  better  informa- 
tion possessed  by  such  a  professional  speculator,  he  gains 
an  enormous  advantage  from  the  sheer  magnitude  or 
breadth  of  the  scope  of  his  operations.  Where  a  single 
flour  miller  or  cotton  spinner  would  be  in  the  market 
once,  the  speculator  enters  it  hundreds  or  thousands  of 
times,  and  his  errors  in  judgment  must  show  a  corre- 
spondingly stronger  tendency  to  cancel  out  and  leave  him 
a  constant  and  predictable  return  on  his  operations. 

The  same  reasoning  holds  good  for  any  method  of 
specializing  uncertainty-bearing.  Specialization  implies 
concentration,  and  concentration  involves  consolidation; 
and  no  matter  how  heterogeneous  the  "cases"  the  gains 
and  losses  neutralize  each  other  in  the  aggregate  to  an  ex- 
tent increasing  as  the  number  of  cases  thrown  together  is 
larger.  Specialization  itself  is  primarily  an  application  of 
the  insurance  principle;  but,  like  large-scale  enterprise,  it 
grows  up  to  meet  uncertainty  situations  where,  on  account 
of  the  impossibility  of  objective  definition  and  external  con- 
trol of  the  individual  ventures  or  uncertainties,  a  "moral 
hazard"  prevents  fflfifljaace  ^y  ap  pvternal  agency  or  a 
loose  association  of  venturers  for  this  single  purpose.^ 


METHODS  FOR  MEETING  UNCERTAINTY     257 

Besides  organized  speculation  as  carried  on  in  connection 
with  produce  and  security  exchanges,  the  principle  of 
specialization  is  exemplified  m  the  tendency  for  the  highly 
uncertain  or  speculative  aspects  of  industry  to  become 
separated  from  the  stable  and  predictable  aspects  and  be 
taken  over  by  different  establishments.  This  is,  of  course, 
what  has  really  taken  place  in  the  ordinary  form  of  spec- 
ulation already  noticed,  namely,  the  separation  of  the 
marketing  function  from  the  technological  side  of  produc- 
tion, the  former  being  much  more  speculative  than  the 
latter.  A  separation  perhaps  equally  significant  in  modern 
economic  life  is  that  which  so  commonly  takes  place  be- 
tween the  establishment  or  founding  of  new  enterprises  and 
their  operation  after  they  are  set  going.  To  be  sure,  by  no 
means  all  the  business  of  promotion  comes  under  this  head, 
but  still  the  tendency  is  manifest.  A  part  of  the  investors 
in  promoted  concerns  look  to  the  future  earnings  from 
regular  operations  for  their  return,  but  a  large  part  expect 
to  sell  out  at  a  profit  after  the  business  is  established,  and 
to  devote  their  capital  to  some  new  venture  of  the  same 
sort.  A  considerable  and  increasing  number  of  individual 
promoters  and  corporations  give  their  exclusive  attention 
to  the  launching  of  new  enterprises,  withdrawing  entirely 
as  soon  as  the  prospects  of  the  business  become  fairly  deter- 
minate. The  gain  from  arrangements  of  this  sort  arises 
largely  from  the  consolidation  of  uncertainties,  their  con- 
version by  grouping  into  measured  risks  which  are  for  the 
group  of  cases  not  uncertainties  at  all.  Such  a  promoter 
takes  it  as  a  matter  of  course  that  a  certain  proportion  of 
his  ventures  will  be  failures  and  involve  heavy  losses, 
while  a  larger  proportion  will  be  relatively  unprofitable, 
and  counts  on  making  his  gains  from  the  occasional  con- 
spicuous successes.  That  is  —  to  face  frankly  that  para- 
doxical element  which  is  really  involved  in  such  calcula- 
tions —  he  does  not  "expect"  to  have  his  "expectations" 
verified  by  the  results  in  every  case;  the  expectations  on 


i 


258  RISK,  UNCERTAINTY,  AND  PROFIT 

which  he  really  counts  are  based  on  an  average,  on  an  "es- 
timate" of  the  long-run  value  of  his  "estimates."  The 
specialization  in  the  speculative  phase  of  the  business  en- 
ables a  single  man  or  firm  to  deal  with  a  larger  number  of 
ventures,  and  is  clearly  a  mode  of  applying  the  same  prin- 
ciple which  underlies  ordinary  insurance. 

Other  illustrations  of  the  same  phenomenon  will  come 
to  the  reader's  mind.  Industries  which  utilize  land  whose 
value  is  largely  speculative  are  more  likely  to  rent  rather 
than  own  their  sites  where  the  nature  of  the  utilization 
makes  such  a  procedure  practicable.  Even  expensive 
machines  and  articles  of  equipment  of  other  sorts,  owner- 
ship of  which  involves  heavy  risks  to  a  small  concern,  may 
be  rented  instead  of  bought  outright.  The  owner  of  leased 
land  or  equipment  is  presumably  a  specialist  in  that  sort  of 
business  and  his  risks  are  reduced  by  the  grouping  of  a 
larger  number  of  ventures. 

Other  advantages  of  specialization  of  speculative  func- 
tions  in  addition  to  the  reduction" of  uncertainty  through 
consolidation  are  manifest,  and  no  intention  of  belittling  or 
concealing  them  is  implied  in  the  separation  of  the  latter 
aspect  of  the  case  in  the  foregoing  discussion.  It  is  apparent 
in  particular  that  the  specialist  in  any  line  of  risk-taking 
naturally  knows  more  about  the  problem  with  which  he 
deals  than  would  a  venturer  who  dealt  with  them  only 
occasionally.  Hence,  since  most  of  these  uncertainties 
relate  chiefly  to  the  exercise  of  judgment,  the  uncertainty 
itself  is  reduced  by  this  fact  also.  There  is  in  this  respect  a 
fundamental  difference  between  the  speculator  or  promoter 
and  the  insurer,  which  must  be  kept  clearly  in  view.  The 
insurer  knows  more  about  the  risk  in  a  particular  case  — 
say  of  a  building  burning  —  but  the  real  risk  is  no  less  be- 
cause he  assumes  it  in  that  particular  case.  His  risk  is  less 
only  because  he  assumes  a  large  number.  But  the  trans- 
fer of  the" risk"  of  an  error  in  judgment  is  a  very  differ- 
ent matter.    The  "insurer"  (entrepreneur,  speculator,  or 


METHODS  FOR  MEETING  UNCERTAINTY      259 

promoter)  now  substitutes  his  own  judgment  for  the  judg- 
ment of  the  man  who  is  getting  rid  of  the  uncertainty 
through  transferring  it  to  the  specialist.  In  so  far  as  his 
knowledge  and  judgment  are  better,  which  they  almost 
certainly  will  be  from  the  mere  fact  that  he  is  a  specialist, 
the  individual  risk  is  less  likely  to  become  a  loss,  in  addition 
to  the  gain  from  grouping.  There  is  better  management, 
greater  economy  in  the  use  of  economic  resources,  as  well 
as  a  mere  transformation  of  uncertainty  into  certainty. 

The  problem  of  meeting  uncertainty  thus  passes  in- 
evitably into  the  general  problem  of  management,  of 
economic  control.  The  fundamental  uncertainties  of  eco- 
nomic  life  are  the  errors  in  predicting  the  future  and  in 
making  present  adjustments  to  ht  future  conditionsTln  so 
far  as  ignorance  of  the  future  is  due  to  practical  indeter- 
minateness  in  nature  itself  we  can  only  appeal  to  the  law  of 
large  numbers  to  distribute  the  losses,  and  make  them 
calculable,  not  to  reduce  them  in  amount,  and  this  is  only 
possible  in  so  far  as  iEe  contingencies  to  be  dealt  with 
admit  of  assimilation  into  homogeneous  groups;  i.e.,  in  so 
far  as  they  repeat  themselves.  When  our  ignorance  of  the 
future  is  only  partial  ignorance,  incomplete  knowledge  and 
imperfect  inference,  it  becomes  impossible  to  classify  in- 
stances objectively,  and  any  changes  brought  about  in  the 
conditions  surrounding  the  formation  of  an  opinion  are 
nearly  sure  to  affect  the  intrinsic  value  of  the  opinion  it- 
self. This  is  true  even  of  the  method  of  grouping  by  extend- 
ing the  scale  of  operations  of  a  single  entrepreneur,  for  the 
quality  of  his  estimates  will  not  be  independent  of  the 
number  he  has  to  make  and  the  mass  of  the  data  involved. 
But  it  is  especially  true  of  grouping  by  specialization,  as 
we  have  seen.  The  inseparability  of  the  uncertainty  prob- 
lem and  the  managerial  problem  will  be  especially  impor- 
tant in  the  discussion  (in  the  next  chapter)  of  entrepreneur- 
ship,  which  is  the  characteristic  phenomenon  of  modern 
economic  organization   and   is  essentially  a  device  for 


260  RISK,  UNCERTAINTY,  AND  PROFIT 

specializing  uncertainty-bearing  or  the  improvement  of 
economic  control.  The  relation  between  management, 
which  consists  of  making  decisions,  and  taking  the  conse- 
quences of  decisions,  which  is  the  most  fundamental  form 
of  risk-taking  in  industry,  will  be  found  to  be  a  very  intri- 
cate as  well  as  intimate  one.  When  the  sequence  of  control 
is  followed  through  to  the  end,  it  will  be  found  that  from 
the  standpoint  of  the  ultimately  responsible  manager,  the 
two  functions  are  always  inseparable. 

We  are  thus  brought  naturally  around  to  a  discussion  of 
the  most  thoroughgoing  methods  of  dealing  with  uncer- 
tainty; i.e.,  by  securing  better  knowledge  of  and  control 
over  the  future.  As  previously  observed,  however,  these 
methods  represent  merely  the  objective  of  all  rational 
conduct  from  the  outset,  and  they  call  for  discussion  in 
such  a  work  as  the  present  only  in  so  far  as  they  affect  the 
general  outline  of  the  social  economic  structure.  Thus  it  is 
fundamental  to  the  entrepreneur  system  that  it  tends  to 
promote  better  management  in  addition  to  consolidating 
risks  and  throwing  them  into  the  hands  of  those  most  dis- 
posed to  assume  them.  The  only  further  comment  here 
called  for  is  to  point  out  the  existence  of  highly  specialized 
industrial  structures  performing  the  functions  of  furnish- 
ing knowledge  and  guidance. 

One  of  the  principal  gains  through  organized  speculation 
is  the  provision  of  information  on  business  conditions, 
making  possible  more  intelligent  forecasting  of  market 
changes.  Not  merely  do  the  market  associations  or  ex- 
changes and  their  members  engage  in  this  work  on  their 
own  account.  Its  importance  to  society  at  large  is  so  well 
recognized  that  vast  sums  of  public  money  are  annually 
expended  in  securing  and  disseminating  information  as  to 
the  output  of  various  industries,  crop  conditions,  and  the 
like.  Great  investments  of  capital  and  elaborate  organiza- 
tions are  also  devoted  to  the  work  as  a  private  enterprise, 
on  a  profit-seeking  basis,  and  the  importance  of  trade 


METHODS  FOR  MEETING  UNCERTAINTY      261 

journals  and  statistical  bureaus  and  services  tends  to  in- 
crease, as  does  that  of  the  activities  of  the  Government  in 
this  field.  The  collection,  digestion,  and  dissemination  in 
usable  form  of  economic  information  is  one  of  the  stagger- 
ing problems  connected  with  our  modern  large-scale  social 
organization.  It  goes  without  saying  that  no  very  satis- 
factory solution  of  this  problem  has  been  achieved,  and  it 
is  safe  to  predict  that  none  will  be  found  in  the  near  future. 
But  all  these  specialized  agencies  for  the  supply  of  informa- 
tion help  to  bridge  the  wide  gap  between  what  the  individ- 
ual business  manager  knows  or  can  find  out  by  the  use  of 
his  own  resources  and  what  he  would  have  to  know  to  con- 
duct his  business  in  a  perfectly  intelligent  fashion.  Their 
output  increases  the  value  of  the  intuitive  "judgments" 
on  the  basis  of  which  his  decisions  are  finally  made  after 
all,  and  greatly  extends  the  scope  of  the  environment  in 
relation  to  which  he  can  more  or  less  intelligently  react. 
The  foregoing  relates  chiefly  to  the  production  side  of 
the  problem  of  economic  information.  In  the  field  of  in- 
formation for  consumers,  we  have  the  still  more  staggering 
development  of  advertising.  This  complex  phenomenon 
cannot  be  discussed  in  detail  here,  beyond  pointing  out  its 
connection  with  the  fact  of  ignorance  and  the  necessity  of 
knowledge  to  guide  conduct.  Only  a  part  of  advertising  is 
in  any  proper  sense  of  the  term  informative.  A  larger  part 
is  devoted  to  persuasion,  which  is  a  different  thing  from 
conviction,  and  perhaps  the  stimulation  or  creation  of  new 
wants  is  a  function  distinguishable  from  either.  In  addi- 
tion to  advertising,  most  of  the  social  outlay  for  education 
is  connected  with  informing  the  population  about  the 
means  of  satisfying  wants,  the  education  of  taste.  The 
outstanding  fact  is  that  the  ubiquitous  presence  of  uncer- 
tainty permeating  every  relation  of  life  has  brought  it 
about  that  information  is  one  of  the  principal  commodities 
that  the  economic  organization  is  engaged  in  supplying. 
From  this  point  of  view  it  is  not  material  whether  the  "in- 


262  RISK,  UNCERTAINTY,  AND  PROFIT 

formation  "  is  false  or  true,  or  whether  it  is  merely  hypnotic 
suggestion.  As  in  all  other  spheres  of  competitive  eco- 
nomic activity,  the  consumer  is  the  final  judge.  If  people 
are  willing  to  pay  for  "Sunny  Jim"  poetry  and  "It  Floats" 
when  they  buy  cereals  and  soap,  then  these  wares  are 
economic  goods.  If  a  certain  name  on  a  fountain  pen  or 
safety  razor  enables  it  to  sell  at  a  fifty  per  cent  higher  price 
than  the  same  article  would  otherwise  fetch,  then  the  name 
represents  one  third  of  the  economic  utility  in  the  article, 
and  is  economically  no  different  from  its  color  or  design  or 
the  quality  of  the  point  or  cutting  edge,  or  any  other  qual- 
ity which  makes  it  useful  or  appealing.  The  morally 
fastidious  (and  naive)  may  protest  that  there  is  a  dis- 
tinction between  "real"  and  "nominal"  utilities;  but 
they  will  find  it  very  dangerous  to  their  optimism  to  at- 
tempt to  follow  the  distinction  very  far.  On  scrutiny  it 
will  be  found  that  most  of  the  things  we  spend  our  incomes 
for  and  agonize  over,  and  notably  practically  all  the  higher 
"spiritual"  values,  gravitate  swiftly  into  the  second  class. 
Somewhat  different  from  the  production  and  sale  of  in- 
formation is  the  dealing  in  actual  instructions  for  the 
guidance  of  conduct  directly.  Modern  society  is  character- 
ized by  the  rapid  growth  of  this  line  of  industry  also.  There 
have  always  been  a  few  professions  whose  activities  con- 
sisted essentially  of  the  sale  of  guidance,  notably  medicine 
and  the  law,  and  more  or  less  the  preaching  and  teach- 
ing professions.  Recent  years,  however,  have  witnessed  a 
veritable  swarming  of  experts  and  consultants  in  nearly 
every  department  of  industrial  life.  The  difference  from 
dealing  in  information  is  that  these  people  do  not  stop  at 
diagnosis;  in  addition  they  prescribe.  They  are  equally  con- 
spicuous in  the  fields  of  business  organization,  accounting, 
the  treatment  of  labor,  the  lay-out  of  plants,  and  the  proc- 
essing of  materials;  they  are  the  scientific  managers  of 
the  managers  of  business;  and  though  they  by  no  means 
serve  business  or  its  managers  for  naught,  and  in  spite  of 


METHODS  FOR  MEETING  UNCERTAINTY     263 

a  large  amount  of  quackery,  they  probably  pay  their  way 
and  more  on  the  whole  in  increasing  the  efficiency  of  pro- 
duction. Certainly  they  do  a  useful  work  in  forcing  the 
intelligent,  critical  consideration  of  business  problems  in- 
stead of  a  blind  following  of  tradition  or  the  use  of  guess- 
work methods.1 

The  last  of  the  alternatives  named  for  meeting  uncer- 
tainty relates  to  the  problem  of  a  tendency  to  prefer  rela- 
tively predictable  lines  of  activity  to  more  speculative 
operations.  It  is  common  to  assume  2  that  society  pays  for 
the  assumption  of  risk  in  the  form  of  higher  prices  for 
commodities  whose  production  involves  uncertainty  and  a 
deficient  supply  of  these  in  comparison  with  goods  of  an 
opposite  character.  This  subject  will  come  up  again  in 
connection  with  the  closely  related  question  of  a  tendency 
of  profit  to  zero,  and  it  seems  best  to  postpone  discussion 
of  it  for  the  present.3  We  shall  find  reasons  for  being  very 
skeptical  as  to  the  reality  of  any  such  abhorrence  of  uncer- 
tainty as  to  decrease  productivity  in  any  line  below  the 
level  that  an  equivalent  fixed  cost  would  bring  about. 

1  On  the  production  and  sale  of  "guidance"  see  J.  M.  Clark,  Journal  of 
Political  Economy,  vol.  26,  Nos.  1  and  2. 

2  Cf .  Willett,  Economic  Theory  of  Risk  and  Insurance,  chap.  ni. 
8  Cf.  chapter  xn. 


CHAPTER  IX 

ENTERPRISE  AND  PROFIT 

We  must  now  consider  more  concretely  and  in  detail  the 
effects  of  uncertainty  on  the  general  form  of  organization 
of  economic  life.  The  best  method  seems  to  be  to  take  up  a 
society  in  which  uncertainty  is  absent,  imagine  uncertainty 
introduced,  and  try  to  ascertain  what  changes  will  take 
place  in  its  structure.  We  therefore  return  to  the  argu- 
ment of  chapter  iv  in  which  the  mechanics  of  exchange  and 
competition  were  studied  with  uncertainty  (and  progress) 
absent.  The  same  method  will  be  followed,  beginning  with 
the  problem  in  as  simple  a  form  as  possible  and  studying 
the  effects  of  different  factors  separately,  analyzing  the 
complexity  of  real  life  "synthetically"  by  building  it  up 
in  imagination  out  of  its  elements. 

To  secure  the  minimum  degree  of  uncertainty  and  at  the 
same  time  keep  the  discussion  as  close  to  reality  as  possible, 
it  is  necessary  to  exercise  some  care  in  defining  the  as- 
sumptions with  which  we  are  working.  The  most  obvious 
initial  requirement  is  to  eliminate  the  factors  of  social 
progress  from  consideration  and  consider  first  a  static 
society.  But  this  postulate  calls  for  discrimination  in 
handling.  In  an  absolutely  unchanging  social  life  there 
would,  as  we  have  repeatedly  observed,  be  no  uncertainty 
whatever,  and  our  analysis  in  chapter  iv  proceeded  on  this 
assumption.  Such  conditions  are  thoroughly  incompatible 
with  the  most  fundamental  facts  of  the  world  in  which  we 
live,  but  their  study  serves  the  analytic  purpose  of  isolating 
the  effects  of  uncertainty.  For  different  kinds  of  change 
and  different  degrees  of  change  are  real  facts,  and  it  will 
therefore  involve  less  abstraction  to  study  hypothetical 
conditions  under  which  change  is  restricted  to  the  most 


ENTERPRISE  AND  PROFIT  265 

fundamental  and  ineradicable  kind  and  amount.  Societies 
may  be  and  have  been  nearly  unprogressive,  and  the  ob- 
vious simplification  to  make  is  therefore  the  elimination  of 
progressive  change. 

After  abstracting  all  the  elements  of  general  progressive 
change  enumerated  in  chapter  v  a  large  amount  of  uncer- 
tainty will  be  left  in  human  life,  due  to  changes  of  the 
character  of  fluctuations  which  cannot  be  thought  away 
without  violence  to  material  possibility.  Strictly  accurate 
formulation  of  conditions  involving  a  realistic  minimum  of 
uncertainty  cannot  be  made,  but  are  not  necessary;  it  is 
sufficient  to  indicate  in  a  rough  way  the  situation  we  pro- 
pose to  discuss.  Several  factors  affect  the  amount  of 
uncertainty  to  be  recognized,  and  have  to  be  taken  into  ac- 
count. The  first  to  be  noted  is  the  time  length  of  the  pro- 
duction process,  for  the  longer  it  is,  the  more  uncertainty 
will  naturally  be  involved.  Of  very  great  importance  also 
is  the  general  level  of  economic  life.  The  lower  wants  of 
man,  those  having  in  the  greatest  degree  the  nature  of 
necessities,  are  the  most  stable  and  predictable.  The  higher 
up  the  scale  we  go,  the  larger  the  proportion  of  the  aes- 
thetic element  and  of  social  suggestion  there  is  involved  in 
motivation,  the  greater  becomes  the  uncertainty  connected 
with  foreseeing  wants  and  satisfying  them.  On  the  pro- 
duction side,  on  the  other  hand,  most  manufacturing  proc- 
esses are  more  controllable  and  calculable  as  to  outcome 
than  are  agricultural  operations  under  usual  conditions. 
We  must  notice  also  the  development  of  science  and  of 
the  technique  of  social  organization.  Greater  ability  to 
forecast  the  future  and  greater  power  to  control  the  course 
of  events  manifestly  reduce  uncertainty,  and  of  still  greater 
importance  is  the  status  of  the  various  devices  noted  in  the 
last  chapter  for  reducing  uncertainty  by  consolidation. 

All  these  perplexities  about  which  some  more  or  less 
definite  assumption  must  be  made  can  be  disposed  of  by 
being  as  realistic  as  possible.  Let  us  say  simply  that  we  are 


266  RISK,  UNCERTAINTY,  AND  PROFIT 

talking  about  the  United  States  in  the  early  years  of  the 
twentieth  century,  but  with  abstraction  made  of  progres- 
sive changes.  That  is,  we  assume  a  population  static  in 
numbers  and  composition  and  without  the  mania  of  change 
and  advance  which  characterizes  modern  life.  Inventions 
and  improvements  in  technology  and  organization  are  to 
be  eliminated,  leaving  the  general  situation  as  we  know  it 
to-day  to  remain  stationary.  Similarly  in  regard  to  the 
saving  of  new  capital,  development  of  new  natural  re- 
sources, redistribution  of  population  over  the  soil  or  re- 
distribution of  ownership  of  goods,  education,  etc.,  among 
the  people.  But  we  shall  not  assume  that  men  are  omnis- 
cient and  immortal  or  perfectly  rational  and  free  from 
caprice  as  individuals.  We  shall  neglect  natural  catastro- 
phes, epidemics,  wars,  etc.,  but  take  for  granted  the 
"usual"  uncertainties  of  the  weather  and  the  like,  along 
with  the  " normal' *  vicissitudes  of  mortal  life,1  and  un- 
certainties of  human  choice. 

Returning  now  to  the  kind  of  social  organization  de- 
scribed in  chapter  iv,2  let  us  inquire  as  to  what  will  be  the 

1  The  situation  which  we  here  endeavor  to  delineate  is  what  Dr.  A.  H. 
Willett  appears  to  have  in  mind  under  the  designation  of  the  "approxi- 
mate static  state."  See  The  Economic  Theory  of  Risk  and  Insurance, 
pp.  15,  16. 

In  this  connection,  again,  we  cannot  be  rigorously  logical  and  definite 
without  getting  off  into  mere  subtleties.  We  do  not  know  whether  there 
is  ultimately  real  uncertainty  and  caprice  in  either  physical  nature  or 
human  nature.  It  may  be  that  all  changes  are  self-compensating  some 
time,  and  that  if  progress  were  eliminated  we  should  finally  achieve  pro- 
phetic powers  in  regard  to  phenomena  in  the  aggregate  (through  applica- 
tion of  the  principle  of  consolidation)  if  not  in  individual  instances.  But 
in  view  of  the  tragically  limited  success  of  science  in  predicting  the  weather, 
for  example,  it  is  clear  that  there  is  no  strain  on  credulity  in  assuming  a 
large  amount  of  real  uncertainty.  We  must  not  forget  that  the  periodicity 
of  change  or  the  interval  required  for  canceling  out  of  fluctuations  is  in 
practice  relative  to  the  length  of  human  life.  If  such  a  cancellation  would 
occur  ultimately  (as  some  writers,  notably  Nietzsche,  have  ventured  to 
suppose)  the  period  is  so  long  in  relation  to  human  life  that  no  advantage 
of  it  could  be  taken. 

2  Chapter  v,  the  reader  will  recall,  dealt  with  the  effects  of  progress 
with  uncertainty  absent.  We  here  retrace  our  steps  somewhat  in  order  to 


ENTERPRISE  AND  PROFIT  267 

effects  of  introducing  the  minimum  degree  of  uncertainty 
into  the  situation.  The  essential  features  of  the  hypotheti- 
cal society  as  thus  far  constructed  need  to  be  kept  clearly 
in  mind.  Acting  as  individuals  under  absolute  freedom 
but  without  collusion,  men  are  supposed  to  have  organized 
economic  life  with  primary  and  secondary  division  of  labor, 
the  use  of  capital,  etc.,  developed  to  the  point  familiar  in 
present-day  America.  The  principal  fact  which  calls  for 
exercise  of  the  imagination  is  the  internal  organization  of 
the  productive  groups  or  establishments.  With  uncertainty 
entirely  absent,  every  individual  being  in  possession  of 
perfect  knowledge  of  the  situation,  there  would  be  no 
occasion  for  anything  of  the  nature  of  responsible  manage- 
ment or  control  of  productive  activity.  Even  marketing 
operations  in  any  realistic  sense  would  not  be  found.  The 
flow  of  raw  materials  and  productive  services  through 
productive  processes  to  the  consumer  would  be  entirely 
automatic. 

We  do  not  need  to  strain  the  imagination  by  supposing 
supernatural  powers  of  prescience  on  the  part  of  men.  We 
can  think  of  the  adjustment  as  the  result  of  a  long  process 
of  experimentation,  worked  out  by  trial-and-error  methods 
alone.  If  the  conditions  of  life  and  the  people  themselves 
were  entirely  unchanging  a  definite  organization  would 
result,  perfect  in  the  sense  that  no  one  would  be  under  an 
incentive  to  change.  So  in  the  organization  of  the  pro- 
ductive groups,  it  is  not  necessary  to  imagine  every  worker 
doing  exactly  the  right  thing  at  the  right  time  in  a  sort  of 
"  preestablished  harmony"  with  the  work  of  others.  There 
might  be  managers,  superintendents,  etc.,  for  the  purpose 
of  coordinating  the  activities  of  individuals.   But  under 

consider  uncertainty  with  progress  absent,  thus  completing  the  design  of 
studying  the  two  factors  separately.  After  completing  the  present  task 
we  shall  (in  chapter  xi)  study  them  in  combination.  A  confusion  between 
the  effects  of  uncertainty  and  those  of  progress,  which  are  largely,  though 
never  quite  completely,  separable  facts,  has  been  seen  to  underlie  the 
reasoning  of  the  "dynamic"  theory  of  profit. 


268  RISK,  UNCERTAINTY,  AND  PROFIT 

conditions  of  perfect  knowledge  and  certainty  such  func- 
tionaries would  be  laborers  merely,  performing  a  purely 
routine  function,  without  responsibility  of  any  sort,  on  a 
level  with  men  engaged  in  mechanical  operations. 

With  the  introduction  of  uncertainty  —  the  fact  of  ig- 
norance and  necessity  of  acting  upon  opinion  rather  than 
knowledge  —  into  this  Eden-like  situation,  its  character 
is  completely  changed.  With  uncertainty  absent,  man's 
energies  are  devoted  altogether  to  doing  things;  it  is 
doubtful  whether  intelligence  itself  would  exist  in  such  a 
situation;  in  a  world  so  built  that  perfect  knowledge  was 
theoretically  possible,  it  seems  likely  that  all  organic  re- 
adjustments would  become  mechanical,  all  organisms 
automata.  With  uncertainty  present,  doing  things,  the 
actual  execution  of  activity,  becomes  in  a  real  sense  a 
secondary  part  of  life;  the  primary  problem  or  function 
is  deciding  what  to  do  and  how  to  do  it.  The  two  most 
important  characteristics  of  social  organization  brought 
about  by  the  fact  of  uncertainty  have  already  been  noticed. 
In  the  first  place,  goods  are  produced  for  a  market,  on  the 
basis  of  an  entirely  impersonal  prediction  of  wants,  not  for 
the  satisfaction  of  the  wants  of  the  producers  themselves. 
The  producer  takes  the  responsibility  of  forecasting  the 
consumers'  wants.  In  the  second  place,  the  work  of  fore- 
casting and  at  the  same  time  a  large  part  of  the  technologi- 
cal direction  and  control  of  production  are  still  further 
concentrated  upon  a  very  narrow  class  of  the  producers, 
and  we  meet  with  a  new  economic  functionary,  the  entre- 
preneur. 

When  uncertainty  is  present  and  the  task  of  deciding 
what  to  do  and  how  to  do  it  takes  the  ascendancy  over  that 
of  execution,  the  internal  organization  of  the  productive 
groups  is  no  longer  a  matter  of  indifference  or  a  mechanical 
detail.1  Centralization  of  this  deciding  and  controlling 
function  is  imperative,  a  process  of  "cephalization,"  such 
1  See  above,  chapter  iv,  p.  106,  note. 


ENTERPRISE  AND  PROFIT  269 

as  has  taken  place  in  the  evolution  of  organic  life,  is  in- 
evitable, and  for  the  same  reasons  as  in  the  case  of  biologi- 
cal evolution.  Let  us  consider  this  process  and  the  cir- 
cumstances which  condition  it.  The  order  of  attack  on  the 
problem  is  suggested  by  the  classification  worked  out  in 
chapter  vn  of  the  elements  in  uncertainty  in  regard  to 
which  men  may  in  large  measure  differ  independently. 

In  the  first  place,  occupations  differ  in  respect  to  the 
kind  and  amount  of  knowledge  and  judgment  required  for 
their  successful  direction  as  well  as  in  the  kind  of  abilities 
and  tastes  adapted  to  the  routine  operations.  Productive 
groups  or  establishments  now  compete  for  managerial 
capacity  as  well  as  skill,  and  a  considerable  rearrangement 
of  personnel  is  the  natural  result.  The  final  adjustment  will 
place  each  producer  in  the  place  where  his  particular  com- 
bination of  the  two  kinds  of  attributes  seems  to  be  most 
effective. 

But  a  more  important  change  is  the  tendency  of  the 
groups  themselves  to  specialize,  finding  the  individuals 
with  the  greatest  managerial  capacity  of  the  requisite  kinds 
and  placing  them  in  charge  of  the  work  of  the  group,  sub- 
mitting the  activities  of  the  other  members  to  their  direc- 
tion and  control.  It  need  hardly  be  mentioned  explicitly 
that  the  organization  of  industry  depends  on  the  funda- 
mental fact  that  the  intelligence  of  one  person  can  be  made 
to  direct  in  a  general  way  the  routine  manual  and  mental 
operations  of  others.  It  will  also  be  taken  into  account 
that  men  differ  in  their  powers  of  effective  control  over 
other  men  as  well  as  in  intellectual  capacity  to  decide  what 
should  be  done.  In  addition,  there  must  come  into  play  the 
diversity  among  men  in  degree  of  confidence  in  their  judg- 
ment and  powers  and  in  disposition  to  act  on  their  opinions, 
to  "venture."  This  fact  is  responsible  for  the  most  funda- 
mental change  of  all  in  the  form  of  organization,  the  sys- 
tem under  which  the  confident  and  venturesome  "assume 
the  risk"  or  "insure"  the  doubtful  and  timid  by  guaran- 


wr 


270  RISK,  UNCERTAINTY,  AND  PROFIT 

teeing  to  the  latter  a  specified  income  in  return  for  an 
assignment  of  the  actual  results. 

Uncertainty  thus  exerts  a  fourfold  tendency  to  select 
men  and  specialize  functions:  (1)  an  adaptation  of  men  to 
occupations  on  the  basis  of  kind  of  knowledge  and  judg- 
ment; (2)  a  similar  selection  on  the  basis  of  degree  of  fore- 
sight, for  some  lines  of  activity  call  for  this  endowment  in 
a  very  different  degree  from  others;  (3)  a  specialization 
within  productive  groups,  the  individuals  with  superior 
managerial  ability  (foresight  and  capacity  of  ruling  others) 
being  placed  in  control  of  the  group  and  the  others  working 
under  their  direction;  and  (4)  those  with  confidence  in  their 
judgment  and  disposition  to  "back  it  up"  in  action  special- 
ize in  risk-taking.  The  close  relations  obtaining  among  these 
tendencies  will  be  manifest.  We  have  not  separated  con- 
fidence and  vent  tiresomeness  at  all,  since  they  act  along 
parallel  lines  and  are  little  more  than  phases  of  the  same 
faculty  —  just  as  courage  and  the  tendency  to  minimize 
danger  are  proverbially  commingled  in  all  fields,  though 
they  are  separable  in  thought.  In  addition  the  tendencies 
numbered  (3)  and  (4)  operate  together.  With  human 
nature  as  we  know  it  it  would  be  impracticable  or  very 
unusual  for  one  man  to  guarantee  to  another  a  definite 
result  of  the  latter 's  actions  without  being  given  power  to 
direct  his  work.  And  on  the  other  hand  the  second  party 
would  not  place  himself  under  the  direction  of  the  first 
without  such  a  guaranty.  The  result  is  a  "double  con- 
tract" of  the  type  famous  in  the  history  of  the  evasion  of 
usury  laws.  It  seems  evident  also  that  the  system  would 
not  work  at  all  if  good  judgment  were  not  in  fact  generally 
associated  with  confidence  in  one's  judgment  on  the  part 
both  of  himself  and  others.  That  is,  men's  judgment  of 
their  own  judgment  and  of  others'  judgment  as  to  both 
kind  and  grade  must  in  the  large  be  much  more  right  than 

ong.1 
1  The  statement  implies  that  a  man's  judgment  has  in  an  effective 


ENTERPRISE  AND  PROFIT  271 

The  result  of  this  manifold  specialization  of  function  is 
enterprise  and  the  wage  system  of  industry.  Its  existence  in 
the  world  is  a  direct  result  of  the  fact  of  uncertainty;  our 
task  in  the  remainder  of  this  study  is  to  examine  this 
phenomenon  in  detail  in  its  various  phases  and  divers  re- 
lations with  the  economic  activities  of  man  and  the  struc- 
ture of  society.  It  is  not  necessary  or  inevitable,  not  the 
only  conceivable  form  of  organization,  but  under  certain 
conditions  has  certain  advantages,  and  is  capable  of  devel- 
opment in  different  degrees.  The  essence  of  enterprise  is 
the  specialization  of  the  function  of  responsible  direction  of 
economic  life,  the  neglected  feature  of  which  is  the  insep- 
arability of  these  two  elements,  responsibility  and  control. 
Under  the  enterprise  system,  a  special  social  class,  the 
business  men,  direct  economic  activity;  they  are  in  the 
strict  sense  the  producers,  while  the  great  mass  of  the 
population  merely  furnish  them  with  productive  services, 
placing  their  persons  and  their  property  at  the  disposal 
of  this  class;  the  entrepreneurs  also  guarantee  to  those  who 
furnish  productive  services  a  fixed  remuneration.  Ac- 
curately to  define  these  functions  and  trace  them  through 
the  social  structure  will  be  a  long  task,  for  the  specializa- 
tion is  never  complete;  but  at  the  end  of  it  we  shall  find 
that  in  a  free  society  the  two  are  essentially  inseparable. 
Any  degree  of  effective  exercise  of  judgment,  or  making 
decisions,  is  in  a  free  society  coupled  with  a  corresponding 
degree  of  uncertainty-bearing,  of  taking  the  responsibility 
for  those  decisions. 

With  the  specialization  of  function  goes  also  a  differen- 
tiation of  reward.  The  produce  of  society  is  similarly  di- 
vided into  two  kinds  of  income,  and  two  only,  contractual 
income,  which  is  essentially  rent,  as  economic  theory  has 
described  incomes,  and  residual  income  or  profit.  But  the 
differentiation  of  contractual  income,  like  that  of  profit,  is 

sense  a  true  or  objective  value.  This  assumption  will  be  justified  by  the 
further  course  of  the  argument. 


272  RISK,  UNCERTAINTY,  AND  PROFIT 

never  complete;  neither  variety  is  ever  met  with  in  a  pure 
form,  and  every  real  income  contains  elements  of  both  rent 
and  profit.  And  with  uncertainty  present  (the  condition 
of  the  differentiation  itself)  it  is  not  possible  even  to  deter- 
mine just  how  much  of  any  income  is  of  one  kind  and  how 
much  of  the  other;  but  a  partial  separation  can  be  made, 
and  the  causal  distinction  between  the  two  kinds  is  sharp 
and  clear. 

We  may  imagine  a  society  in  which  uncertainty  is  absent 
transformed  on  the  introduction  of  uncertainty  into  an 
enterprise  organization.  The  readjustments  will  be  carried 
out  by  the  same  trial-and-error  methods  under  the  same 
motives,  the  effort  of  each  individual  to  better  himself, 
which  we  have  already  described.  The  ideal  or  limiting 
condition  constantly  in  view  would  still  be  the  equaliza- 
tion of  all  available  alternatives  of  conduct  by  each  in- 
dividual through  the  distribution  of  efforts  and  of  expendi- 
ture of  the  proceeds  of  effort  among  the  lines  open.  Under 
the  new  system  labor  and  property  services  actually  come 
into  the  market,  become  commodities  and  are  bought  and 
sold.  They  are  thus  brought  into  the  comparative  value 
scale  and  reduced  to  homogeneity  in  price  terms  with  the 
fund  of  values  made  up  of  the  direct  means  of  want  satis- 
faction. 

Another  feature  of  the  new  adjustment  is  that  a  condi- 
tion of  perfect  equilibrium  is  no  longer  possible.  Since 
productive  arrangements  are  made  on  the  basis  of  anticipa- 
tions and  the  results  actually  achieved  do  not  coincide  with 
these  as  a  usual  thing,  the  oscillations  will  not  settle  down 
to  zero.  For  all  changes  made  by  individuals  relate  to  the 
established  value  scale  and  this  price-system  will  be  subject 
to  fluctuations  due  to  unforeseen  causes;  consequently  in- 
dividual changes  in  arrangements  will  continue  indefinitely 
to  take  place.  The  experiments  by  which  alone  the  value  of 
human  judgment  is  determined  involve  a  proportion  of 
failures  or  errors,  are  never  complete,  and  in  view  of  hu- 


ENTERPRISE  AND  PROFIT  273 

man  mortality  have  constantly  to  be  recommenced  at  the 
beginning. 

We  turn  now  to  consider  in  broad  outline  the  two  types 
of  individual  income  implied  in  the  enterprise  system  of  or- 
ganization, contractual  income  and  profit.1  We  shall  try  as 
hitherto  to  explain  events  by  placing  ourselves  in  the  actual 
positions  of  the  men  acting  or  making  decisions  and  inter- 
preting their  acts  in  terms  of  ordinary  human  motives. 
The  setting  of  the  problem  is  a  free  competitive  situation 
in  which  all  men  and  material  agents  are  competing  for 
employment,  including  all  men  at  the  time  engaged  as  en- 
trepreneurs, while  all  entrepreneurs  are  competing  for  pro- 
ductive services  and  at  the  same  time  all  men  are  competing 
for  positions  as  entrepreneurs.  The  essential  fact  in  under- 
standing the  reaction  to  this  situation  is  that  men  are  act- 
ing, competing,  on  the  basis  of  what  they  think  of  the 
future.  To  simplify  the  picture  and  make  it  concrete  we 
shall  as  before  assume  that  there  exists  some  sort  of  group- 
ing of  men  and  things  under  the  control  of  other  men  as 
entrepreneurs  (a  random  grouping  will  do  as  a  start)  and 
that  entrepreneurs  and  others  are  in  competition  as  above 
stated. 

The  production-distribution  system  is  worked  out 
through  offers  and  counter-offers,  made  on  the  basis  of 
anticipations,  of  two  kinds.  The  laborer  asks  what  he  thinks 
the  entrepreneur  will  be  able  to  pay,  and  in  any  case  will 
not  accept  less  than  he  can  get  from  some  other  entrepre- 
neur, or  by  turning  entrepreneur  himself.  In  the  same  way 
the  entrepreneur  offers  to  any  laborer  what  he  thinks  he 
must  in  order  to  secure  his  services,  and  in  any  case  not 

1  As  already  observed,  the  theoretical  features  of  contractual  income 
are  those  associated  with  rent  in  the  conventional  distributive  analysis. 
From  the  point  of  view  of  our  present  assumptions,  all  productive  goods 
being  fixed  in  amount  and  in  their  distribution  among  the  members  of 
society,  such  incomes  might  naturally  be  called  wages.  As  we  have  in- 
sisted that  there  is  no  significant  causal  or  ethical  difference  in  the  sources 
of  income  it  does  not  particularly  matter  what  they  are  called. 


274  RISK,  UNCERTAINTY,  AND  PROFIT 

more  than  he  thinks  the  laborer  will  actually  be  worth  to 
him,  keeping  in  mind  what  he  can  get  by  turning  laborer 
himself.  The  whole  calculation  is  in  the  future;  past  and 
even  present  conditions  operate  only  as  grounds  of  pre- 
diction as  to  what  may  be  anticipated.1 

Since  in  a  free  market  there  can  be  but  one  price  on  any 
commodity,  a  general  wage  rate  must  result  from  this  com- 
petitive bidding.  The  rate  established  may  be  described 
as  the  socially  or  competitively  anticipated  value  of  the 
laborer's  product,  using  the  term  "product "  in  the  sense  of 
specific  contribution,  as  already  explained.  It  is  not  the 
opinion  of  the  future  held  by  either  party  to  an  employment 
bargain  which  determines  the  rate;  these  opinions  merely 
set  maximum  and  minimum  limits  outside  of  which  the 
agreement  cannot  take  place.  The  mechanism  of  price  ad- 
justment is  the  same  as  in  any  other  market.  There  is  al- 
ways an  established  uniform  rate,  which  is  kept  constantly 
at  the  point  which  equates  the  supply  and  demand.  If  at 
any  moment  there  are  more  bidders  willing  to  employ  at  a 
higher  rate  than  there  are  employees  willing  to  accept  the 
established  rate,  the  rate  will  rise  accordingly,  and  similarly 
if  there  is  a  balance  of  opinion  in  the  opposite  direction. 
The  final  decision  by  any  individual  as  to  what  to  do  is 
based  on  a  comparison  of  a  momentarily  existing  price  with 
a  subjective  judgment  of  significance  of  the  commodity. 
The  judgment  in  this  case  relates  to  the  indirect  significance 
derived  from  a  twofold  estimate  of  the  future,  involving 

1  In  actual  society  freedom  of  choice  between  employer  and  employee 
status  depends  normally  on  the  possession  of  a  minimum  amount  of  capi- 
tal. The  degree  of  abstraction  involved  in  assuming  such  freedom  is  not 
serious,  however,  since  demonstrated  ability  can  always  get  funds  for 
business  operations.  A  propertyless  employer  can  make  the  contractual 
payments  secure  by  insurance  even  when  they  may  involve  loss,  and  com- 
plete separation  of  the  risk-taking  and  control  function  from  that  of  fur- 
nishing productive  services  is  possible  if  there  is  a  high  development  of 
organization  and  a  high  code  of  business  honor.  But  the  conditions 
generally  necessary  in  real  life  for  the  giving  of  effective  guarantees  must 
also  be  taken  into  account  as  we  proceed. 


ENTERPRISE  AND  PROFIT  275 

both  technological  and  price  uncertainties.  The  employer 
in  deciding  whether  to  offer  the  current  wage,  and  the  em- 
ployee in  deciding  whether  to  accept  it,  must  estimate  the 
technical  or  physically  measured  product  (specific  con- 
tribution) of  the  labor  and  the  price  to  be  expected  for 
that  product  when  it  comes  upon  the  market.  The  es- 
timation may  involve  two  sorts  of  calculation  or  estimate 
of  probability.  The  venture  itself  may  be  of  the  nature  of 
a  gamble,  involving  a  large  proportion  of  inherently  un- 
predictable factors.  In  such  a  case  the  decision  depends 
upon  an  "estimate"  of  an  "objective  probability"  of 
success,  or  of  a  series  of  such  probabilities  corresponding 
to  various  degrees  of  success  or  failure.  And  normally,  in 
the  case  of  intelligent  men,  account  will  be  taken  of  the 
probable  "true  value"  of  the  estimates  in  the  case  of 
all  estimated  factors. 

The  meaning  of  the  term  "social"  or  "competitive" 
anticipation  will  now  be  clear.  The  question  in  the  mind  of 
either  party  to  an  employment  agreement  relates  simply 
to  the  fact  of  a  difference  between  the  current  standard  of 
remuneration  for  the  services  being  bargained  for  and  his 
own  estimate  of  their  worth,  discounted  by  probability 
allowances.  The  magnitude  of  the  difference  is  altogether 
immaterial.  The  prospective  employer  may  know  abso- 
lutely that  the  service  has  a  value  to  him  ever  so  much 
greater  than  the  price  he  is  paying,  but  he  will  have  to  pay 
only  the  competitively  established  rate,  and  his  purchase 
will  affect  this  rate  no  more  than  if  he  were  ever  so  hesitant 
about  the  bargain,  just  so  he  makes  it.  It  is  the  general 
estimate  of  the  magnitudes  involved,  in  the  sense  of  a 
"marginal"  demand  price,  which  fixes  the  actual  current 
rate. 

In  many  respects  the  nature  of  the  organization  we  are 
now  dealing  with  is  the  same  as  that  described  in  chapter 
iv,  with  uncertainty  and  progress  absent.  The  value  of  a 
laborer  or  piece  of  material  equipment  to  a  particular  pro- 


276  RISK,  UNCERTAINTY,  AND  PROFIT 

ductive  group  is  determined  by  the  specific  physical  con- 
tribution to  output  under  the  principle  of  diminishing  re- 
turns with  increase  in  the  proportion  of  that  kind  of  agency 
in  the  combination,  and  on  the  price  of  this  contribution 
under  the  principle  of  diminishing  utility  with  increase  in 
the  proportion  of  productive  energy  devoted  to  making 
the  particular  product  turned  out  by  the  establishment  in 
question.  But  the  facts  upon  which  the  working-out  of  the 
organization  depends  can  no  longer  be  objectively  deter- 
mined with  accuracy  by  experiment;  all  the  data  in  the 
case  must  be  estimated,  subject  to  a  larger  or  smaller  mar- 
gin of  error,  and  this  fact  causes  differences  more  funda- 
mental than  the  resemblances  in  the  two  situations.  The 
function  of  making  these  estimates  and  of  "guaranteeing" 
their  value  to  the  other  participating  members  of  the  group 
falls  to  the  responsible  entrepreneur  in  each  establishment, 
producing  a  new  type  of  activity  and  a  new  type  of  income 
entirely  unknown  in  a  society  where  uncertainty  is  absent. 
Even  in  the  hypothetical  situation  dealt  with  in  chap- 
ter iv  there  would  be  likely  to  be  a  concentration  of  certain 
control  and  coordinating  functions  in  a  separate  person  or 
group  of  persons  in  each  productive  group.  But  the  duties 
of  such  persons  would  be  of  a  routine  character  merely,  in 
no  significant  respect  different  from  those  of  any  other  op- 
eratives; they  would  be  laborers  among  laborers  and  their 
incomes  would  be  wages  like  other  wages.  When,  however, 
the  managerial  function  comes  to  require  the  exercise  of 
judgment  involving  liability  to  error,  and  when  in  con- 
sequence the  assumption  of  responsibility  for  the  correct- 
ness of  his  opinions  becomes  a  condition  prerequisite  to 
getting  the  other  members  of  the  group  to  submit  to  the 
manager's  direction,  the  nature  of  the  function  is  revolu- 
tionized; the  manager  becomes  an  entrepreneur.  He  may, 
and  typically  will,  to  be  sure,  continue  to  perform  the  old 
mechanical  routine  functions  and  to  receive  the  old  wages; 
but  in  addition  he  makes  responsible  decisions,  and  his 


ENTERPRISE  AND  PROFIT  277 

income  will  normally  contain  in  addition  to  wages  a  pure 
differential  element  designated  as  "profit"  by  the  economic 
theorist.  This  profit  is  simply  the  difference  between  the 
market  price  of  the  productive  agencies  he  employs,  the 
amount  which  the  competition  of  other  entrepreneurs 
forces  him  to  guarantee  to  them  as  a  condition  of  securing 
their  services,  and  the  amount  which  he  finally  realizes 
from  the  disposition  of  the  product  which  under  his  direc- 
tion they  turn  out. 

The  character  of  the  entrepreneur's  income  is  evidently 
complex,  and  the  relations  of  its  component  elements  sub- 
tle. It  contains  an  element  which  is  ordinary  contractual 
income,  received  on  the  ground  of  routine  services  per- 
formed by  the  entrepreneur  personally  for  the  business 
(wages)  or  earned  by  property  which  belongs  to  him  (rent 
or  capital  return).  And  the  differential  element  is  again 
complex,  for  it  is  clear  that  there  is  an  element  of  calcula- 
tion and  an  element  of  luck  in  it.  An  adequate  examination 
and  analysis  of  this  phenomenon  requires  time  and  careful 
thinking.  The  background  of  the  problem  should  now  be 
clear:  the  uncertainty  of  all  life  and  conduct  which  call  for 
the  exercise  of  judgment  in  business,  the  economy  of  divi- 
sion of  labor  which  compels  men  to  work  in  groups  and  to 
delegate  the  function  of  control  as  other  functions  are 
specialized,  the  facts  of  human  nature  which  make  it 
necessary  for  one  who  directs  the  activities  of  others  to  as- 
sume responsibility  for  the  results  of  the  operations,  and 
finally  the  competitive  situation  which  pits  the  judgment 
of  each  entrepreneur  against  that  of  the  extant  business 
world  in  adjusting  the  contractual  incomes  which  he  must  [ 
pay  before  he  gets  anything  for  himself. 

The  first  step  in  attacking  the  problem  is  to  inquire  into 
the  meaning  of  entrepreneur  ability  and  its  conditions  of 
demand  and  supply.  In  regard  to  the  first  main  division 
of  the  entrepreneur's  income,  the  ordinary  wage  for  the 
routine  services  of  labor  and  property  furnished  to  the 


278  RISK,  UNCERTAINTY,  AND  PROFIT 

business,  no  comment  is  necessary.  This  return  is  merely 
the  competitive  rate  of  pay  for  the  grade  of  ability  or  kind 
of  property  in  question.  To  be  sure,  it  may  not  be  possible 
in  practice  to  say  exactly  what  this  rate  is.  Not  merely  is 
perfect  standardization  of  things  and  services  unattainable 
under  the  fluctuating  conditions  of  real  life,  but  in  addition 
the  conditions  of  the  entrepreneur  specialization  may  well 
bring  it  about  that  the  same  things  are  not  done  under 
closely  comparable  conditions  by  entrepreneurs  and  non- 
entrepreneurs.  Hence  the  separation  between  the  pure 
wage  or  rent  element  and  the  elements  arising  out  of  un- 
certainty cannot  generally  be  made  with  complete  accu- 
racy. The  serious  difficulty  comes  with  the  attempt  to  deal 
with  the  relation  between  judgment  and  luck  in  deter- 
mining that  part  of  the  entrepreneur's  income  which  is 
associated  with  the  performance  of  his  peculiar  twofold 
function  of  (a)  exercising  responsible  control  and  (b)  se- 
curing the  owners  of  productive  services  against  uncer- 
tainty and  fluctuation  in  their  incomes.  Clearly  this 
special  income  is  also  connected  with  a  sort  of  effort  and 
sacrifice  and  into  the  nature  and  conditions  of  supply  and 
demand  of  the  capacities  and  dispositions  for  these  efforts 
and  sacrifices  it  must  be  pertinent  to  inquire. 

It  is  unquestionable  that  the  entrepreneur's  activities 
effect  an  enormous  saving  to  society,  vastly  increasing  the 
efficiency  of  economic  production.  Large-scale  operations, 
highly  organized  industry,  and  minute  division  of  labor 
would  be  impossible  without  specialization  of  the  manage- 
rial function,  and  human  nature  being  as  it  is,  the  guaran- 
teeing function  must  apparently  go  along  with  that  of  con- 
trol; indeed,  in  the  ultimate  sense  of  control  the  two  are 
not  even  theoretically  separable.  Thus  there  would  be  a 
large  saving  even  outside  of  any  question  of  the  superior 
abilities  of  certain  individuals  over  other  individuals  for 
the  performance  of  this  function.  And  there  is  still  another 
gain  of  large  magnitude  through  the  reduction  of  uncer- 


ENTERPRISE  AND  PROFIT  279 

tainty  by  the  principle  of  consolidation,  which  also  is  in- 
dependent of  the  personal  attributes  of  the  entrepreneur. 
But  these  economies,  due  to  the  system  as  such,  and  not  to 
activities  of  the  individuals  performing  a  special  function, 
accrue  to  society;  no  cause  can  be  discovered  in  this  con- 
nection alone  which  would  give  rise  to  a  special  distributive 
share. 

As  to  the  actual  comparative  magnitude  of  the  various 
elements  of  gain  secured  through  the  enterprise  system  it 
would  be  rash  to  guess,  but  certainly  a  very  large  real  gain 
is  secured  through  the  selection  of  managers  having  su- 
perior fitness  for  the  work.  Now  it  is  of  supreme  importance 
that  such  selection  is  possible  only  because  and  in  so  far  as 
such  fitness  can  be  identified  in  advance  of  its  demonstra- 
tion in  each  particular  case.  The  prospective  entrepreneur 
himself  has  an  opinion  of  his  own  suitability,  in  so  far  as  he 
forms  an  estimate  of  the  true  value  of  his  prognostications 
and  policies.  Other  persons  may  or  may  not  agree  with  his 
opinion  of  himself.  A  man  may  actually  get  into  the  posi- 
tion of  entrepreneur  in  several  ways.  If  he  has  property 
or  known  personal  productive  powers  of  a  technological 
sort  he  may  assume  the  functions  of  entrepreneur  without 
convincing  any  one  outside  himself  of  any  special  fitness  to 
exercise  them.  As  long  as  his  own  resources  safeguard  the 
interests  of  the  persons  to  whom  he  agrees  to  pay  con- 
tractual incomes  these  persons  need  not  worry  about  the 
correctness  of  the  judgments  on  which  the  entrepreneur's 
policies  are  based.  If  he  cannot  make  such  guarantees  he 
must,  of  course,  convince  either  the  persons  with  whom  he 
makes  wage  or  rent  bargains  or  some  outside  party  who 
will  underwrite  the  guarantees  for  him.  The  effect  of  this 
transfer  of  the  guarantee  function  on  the  nature  of  entre- 
preneurship  is  a  subtle  question  and  will  be  taken  up 
presently.  It  might  even  conceivably  happen,  in  the  third 
place,  that  a  person  not  judging  himself  especially  fit  to 
control  industrial  policies  would  get  into  the  place  of  entre- 


280  RISK,  UNCERTAINTY,  AND  PROFIT 

preneur,  if  other  persons  have  a  sufficiently  high  opinion 
of  his  abilities  and  trustworthiness.  This  case  is  more  com- 
plicated still  and  its  treatment  must  also  be  deferred.  Dis- 
cussion of  divided  entrepreneurship  will  lead  naturally  to 
the  problem  of  the  hired  manager,  most  difficult  of  all.  Let 
us  consider  first  the  simple  case  of  unique  and  undivided 
exercise  of  the  function,  the  control  and  uncertainty- 
bearing  being  all  concentrated  in  the  same  individual, 
under  the  assumption  that  outsiders  whether  employed  by 
him  or  not  have  neither  opinions  upon  nor  interest  in  the 
question  of  his  competence.  It  will  further  simplify  the 
problem  if  we  begin  by  assuming  that  this  is  the  only  type 
of  entrepreneurship  in  our  society. 

First,  a  further  word  as  to  the  character  of  the  process 
by  which  the  entrepreneur's  income  is  fixed.  It  may  be  dis- 
tinguished from  the  contractual  returns  received  for  serv- 
ices not  involving  the  exercise  of  judgment,  and  which  are 
paid  by  the  entrepreneur,  by  pointing  out  that  the  latter 
are  imputed,  while  his  own  income  is  residual.  That  is,  in  a 
sense,  the  entrepreneur's  income  is  not  "determined"  at 
all;  it  is  "what  is  left"  after  the  others  are  "determined." 
The  competition  of  entrepreneurs  bidding  in  the  market 
for  the  productive  services  in  existence  in  the  society  "fix" 
prices  upon  these;  the  entrepreneur's  income  is  not  fixed, 
but  consists  of  whatever  remains  over  after  the  fixed  in- 
comes are  paid.  Hence  we  must  examine  the  entrepreneur's 
income  indirectly,  by  inquiring  into  the  forces  which 
determine  the  fixed  incomes,  in  relation  to  the  whole  pro- 
duct of  an  enterprise  or  of  society. 

Assuming  perfect  competition  in  the  market  for  pro- 
ductive services,  the  contractual  incomes  are  fixed  for 
every  entrepreneur  by  the  competitive  or  marginal  antici- 
pations of  entrepreneurs  as  a  group  in  relation  to  the  supply 
of  each  kind  of  agency  in  existence.  Whether  any  particular 
individual  becomes  an  entrepreneur  or  not  depends  on  his 
believing  (strongly  enough  to  act  upon  the  conviction) 


ENTERPRISE  AND  PROFIT  281 

I  that  he  can  make  productive  services  yield  more  than  the 
price  fixed  upon  them  by  what  other  persons  think  they  can 
make  them  yield  (with  the  same  provision  that  the  belief 
must  lead  to  action).  After  any  individual  has  become  an 
entrepreneur,  the  amount  of  his  income  depends  on  his  suc- 
cess in  producing  the  anticipated  excess,  and  in  this  sense 
is  a  matter  of  the  correctness  of  his  judgment.  But  it  is >Vs 
clear  that  his  success  is  equally  a  matter  of  (a)  the  failure  of 
the  judgment,  or  (b)  an  inferiority  in  capacity,  on  the  part 
of  his  competitors.  The  two  factors  of  (a)  capacity  and 
(b)  judgment  of  one's  capacity  are  inseparably  connected, 
and  business  capacity  is  again  compounded  of  judgment 
(of  factors  external  to  the  person  judging)  and  executive 
capacity. 

Moreover,  there  is  in  the  exercise  of  the  best  judgment 
and  highest  capacity  an  inevitable  margin  of  error.  A 
successful  outcome  in  any  particular  case  cannot  be  at- 
tributed entirely  to  judgment  and  capacity  even  taken  to- 
gether. The  best  men  would  fail  in  a  certain  proportion  of 
cases  and  the  worst  perhaps  succeed  in  a  certain  propor- 
tion. The  results  of  one  trial  or  of  a  small  number  of  trials 
can  at  most  establish  a  certain  presumption  in  favor  of  the 
view  that  ability  has  or  has  not  been  shown.1  A  dependable 
estimate  of  ability  can  only  come  from  a  considerable  num- 
ber of  trials.  Even  then  there  are  differences  in  kind  of 
ability,  as  well  as  degree.  And  in  business  management  no 
two  instances,  perhaps,  are  ever  very  closely  alike,  in  any 
objective,  describable  sense.  It  is  one  of  the  mysteries  of 
the  workings  of  mind  that  we  are  able  to  form  estimates  of 
"general  ability "  which  have  any  value,  but  the  fact  that 
we  do  is  of  course  indisputable. 

1  As  has  been  well  observed  in  connection  with  games  of  skill.  It  is  not 
necessarily  a  proof  of  high  skill  to  make  a  twenty-foot  putt  in  golf  or 
pierce  a  two-inch  bull's-eye  at  a  hundred  yards  with  a  rifle;  nor  a  lack  of 
skill  to  miss  a  three-foot  putt  or  strike  outside  the  eight-inch  circle. 
Either  would  happen  sometimes  with  good  shots  or  poor;  only  the  pro- 
portion of  successes  and  failures  in  a  fair  number  of  trials  gives  any  in- 
dication of  real  ability  to  do  the  trick. 


282  RISK,  UNCERTAINTY,  AND  PROFIT 

Still  further,  the  venture  itself  may  be  a  gamble,  as  we 
have  repeatedly  pointed  out.  Most  decisions  calling  for  the 
exercise  of  judgment  in  business  or  responsible  life  in  any 
field  involve  factors  not  subject  to  estimate  and  which  no 
one  makes  any  pretense  of  estimating.  The  judgment  it- 
self is  a  judgment  of  the  probability  of  a  certain  outcome, 
of  the  proportion  of  successes  which  would  be  achieved  if 
the  venture  could  be  repeated  a  large  number  of  times. 
The  allowance  for  luck  is  therefore  twofold.  It  requires  a 
large  number  of  trials  to  show  the  real  probabilities  in  re- 
gard to  which  judgment  is  exercised  in  any  given  kind  of 
case  as  well  as  to  distinguish  between  intrinsic  quality  in  the 
judgment  and  mere  accident.  And  bearing  in  mind  again 
the  extreme  crudeness  of  the  classification  of  instances  at 
best,  the  marvel  grows  that  we  are  able  to  live  as  intelli- 
gently as  we  do.  Let  us  now  attempt  to  state  the  principles 
determining  entrepreneur  income  more  accurately  and  in 
the  form  of  laws  of  demand  and  supply. 

The  demand  for  a  productive  service  depends  upon  the 
steepness  of  the  curve  of  diminishing  returns  from  increas- 
ing amounts  of  other  kinds  of  services  applied  to  the  first. 
In  the  familiar  case  of  land,  the  more  rapidly  the  returns 
from  increased  applications  of  labor  and  capital  applied  to  a 
given  plot  of  land  fall  off,  the  higher  will  be  the  rent  on 
land.  Now  there  is  evidently  a  law  of  diminishing  returns 
governing  the  combination  of  productive  services  with 
entrepreneurs.  It  is  based  on  the  fact  already  stated  of 
limitation  in  the  space  range  of  foresight  and  executive 
capacity.  The  greater  the  magnitude  of  operations  which 
any  single  individual  attempts  to  direct  the  less  effective  in 
general  he  will  be  —  "beyond  a  certain  point,"  as  in  other 
cases  of  the  law.  The  demand  for  entrepreneurs,  again, 
like  that  for  any  productive  agency,  depends  directly  upon 
the  supply  of  other  agencies. 

The  supply  of  entrepreneurs  involves  the  factors  of 
(a)  ability,  with  the  various  elements  therein  included, 


ENTERPRISE  AND  PROFIT  283 

(b)  willingness,  (c)  power  to  give  satisfactory  guarantees, 
and  (d)  the  coincidence  of  these  factors.  If  society  as  a 
whole  secures  a  high  quality  of  management  for  its  enter- 
prises it  will  be  through  a  coincidence  of  ability  with  will- 
ingness, or  of  all  three  factors,  as  well  as  through  an  abun- 
dant supply  of  the  elements  separately.  Willingness  plus 
power  to  give  guarantees,  not  backed  up  by  ability,  will 
evidently  lead  to  a  dissipation  of  resources,  while  ability 
without  the  other  two  factors  will  be  merely  wasted.  To 
find  men  capable  of  managing  business  efficiently  and 
secure  to  them  the  positions  of  responsible  control  is  per- 
haps the  most  important  single  problem  of  economic  or- 
ganization on  the  efficiency  side. 

The  supply  of  entrepreneur  qualities  in  society  is  one  of 
the  chief  factors  in  determining  the  number  and  size  of  its 
productive  units.  It  is  a  common  and  perhaps  justifiable 
opinion  that  most  of  the  other  factors  tend  toward  greater 
economy  with  increasing  size  in  the  establishment,  and  that 
the  chief  limitation  on  size  is  the  capacity  of  the  leadership. 
If  this  is  true  the  ability  to  handle  large  enterprises  suc- 
cessfully, when  it  is  met  with,  must  tend  to  secure  very 
large  rewards.  The  income  of  any  particular  entrepreneur 
will  in  general  tend  to  be  larger:  (1)  as  he  himself  has  abil- 
ity, and  good  luck;  but  (2),  perhaps  more  important,  as 
there  is  in  the  society  a  scarcity  of  self-confidence  com- 
bined with  the  power  to  make  effective  guarantees  to  em- 
ployees. The  abundance  or  scarcity  of  mere  ability  to 
manage  business  successfully  exerts  relatively  little  in- 
fluence on  profit;  the  main  thing  is  the  rashness  or  timidity 
of  entrepreneurs  (actual  and  potential)  as  a  class  in  bidding 
up  the  prices  of  productive  services.  Entrepreneur  in- 
come, being  residual,  is  determined  by  the  demand  for  these 
other  services,  which  demand  is  a  matter  of  the  self-con- 
fidence of  entrepreneurs  as  a  class,  rather  than  upon  a 
demand  for  entrepreneur  services  in  a  direct  sense.  We 
must  see  at  once  that  it  is  perfectly  possible  for  entre- 


284  RISK,  UNCERTAINTY,  AND  PROFIT 

preneurs  as  a  class  to  sustain  a  net  loss,  which  would 
merely  have  to  be  made  up  out  of  their  earnings  in  some 
other  capacity.  This  would  be  the  natural  result  in  a 
population  combining  low  ability  with  high  "courage." 
On  the  other  hand,  if  men  generally  judge  their  own  abili- 
ties well,  the  general  rate  of  profit  will  probably  be  low, 
whether  ability  itself  is  low  or  high,  but  much  more  va- 
riable and  fluctuating  for  a  low  level  of  real  capacity.  The 
condition  for  large  profits  is  a  narrowly  limited  supply  of 
high-grade  ability  with  a  low  general  level  of  initiative  as 
well  as  ability. 

The  analysis  of  profit  is  much  simplified  for  students  of 
political  economy  by  the  fact  that  the  conventional  dis- 
tribution has  placed  such  (misguided)  emphasis  on  the 
concept  of  residual  income,  notably,  of  course,  in  the  treat- 
ment of  rent.  Yet  it  will  not  do  to  press  the  parallel  too  far, 
for  there  is  this  important  difference :  Rent  —  and  as  every 
one  now  understands,  any  other  share  as  well  —  is  residual 
after  the  products  of  the  other  shares  are  deducted  (pro- 
duct being  the  marginal  contribution  of  a  single  unit 
multiplied  by  the  number  of  units).  But  profit  (under  the 
simplified  conditions  we  are  now  dealing  with)  is  the  residue 
after  deduction  of  the  payment  for  the  other  agencies, 
determined  by  the  marginal  bid  of  entrepreneurs  as  a 
class  for  all  agencies  as  aggregates.  The  residue  in  the 
latter  case  is  not  a  product  residue,  but  a  margin  of  error 
in  calculation  on  the  part  of  the  non-entrepreneurs  and 
entrepreneurs  who  do  not  force  the  successful  entrepre- 
neurs to  pay  as  much  for  productive  services  as  they  could 
be  forced  to  pay. 

As  the  argument  is  quite  complicated,  it  will  be  well  to 
recapitulate.  We  have  assumed  in  this  first  approximation 
that  each  man  in  society  knows  his  own  powers  as  entre- 
preneur, but  that  men  know  nothing  about  each  other  in 
this  capacity.  The  division  of  social  income  between  pro- 
fits and  contractual  income  then  depends  on  the  supply  of 


ENTERPRISE  AND  PROFIT  285 

entrepreneur  ability  in  the  society  and  the  rapidity  of 
diminishing  returns  from  (other  factors  applied  to)  it,  the 
size  of  the  profit  share  increasing  as  the  supply  of  ability  is 
small  and  as  the  returns  diminish  more  rapidly.  If  men  are 
poor  judges  of  their  own  powers  as  well  as  ignorant  of 
those  of  other  men,  the  size  of  the  profit  share  depends  on 
whether  they  tend  on  the  whole  to  overestimate  or  under- 
estimate the  prospects  of  business  operations,  being  larger 
if  they  underestimate.  These  statements  abstract  from  the 
question  of  possession  of  means  to  guarantee  the  fixed 
incomes  which  they  contract  to  pay;  limitations  in  this 
respect  act  as  limitations  on  the  supply  of  entrepreneur 
ability.  If  entrepreneur  ability  is  of  such  high  quality  that 
it  practically  is  not  subject  to  diminishing  returns,  the 
competition  among  even  a  very  few  such  men  will  raise 
the  rate  of  contractual  returns  and  lower  the  residual  share, 
if  they  know  their  own  powers.  If  they  do  not,  the  size  of 
their  profits  will  again  depend  on  their  "optimism,"  vary- 
ing inversely  with  the  latter. 

A  man's  knowledge  of  his  own  powers  involves  knowledge 
of  the  amount  of  uncertainty  he  deals  with  in  trusting  his 
own  judgment,  which,  if  the  scale  of  operations  is  large 
enough,  means  the  absence  of  uncertainty  in  the  effective 
sense,  if  the  knowledge  is  complete.  Even  if  judgment  it- 
self subject  to  error  is  exercised  in  regard  to  the  real  prob- 
abilities in  an  intrinsic  gambling  situation,  we  have  for  the 
uncertainty  in  the  situation  as  a  whole  an  objective  prob- 
ability with  predictable  results  for  a  large  number  of  cases. 
The  presence  of  true  profit,  therefore,  depends  on  an  ab- 
solute uncertainty  in  the  estimation  of  the  value  of  judg- 
ment, or  on  the  absence  of  the  requisite  organization  for 
combining  a  sufficient  number  of  instances  to  secure  cer- 
tainty through  consolidation.  With  men  in  complete  igno- 
rance of  the  powers  of  judgment  of  other  men  it  is  hard  to 
see  how  such  organization  could  be  effected.  Yet  so  elusive 
is  the  mechanism  by  which  we  know  our  world,  so  great  the 


286  RISK,  UNCERTAINTY,  AND  PROFIT 

capacity  of  mind  for  seizing  upon  indirect  methods  of  in- 
creasing certainty,  that  a  further  sweeping  reservation  must 
be  made.  If  men,  ignorant  of  other  men's  powers,  know 
that  these  other  men  themselves  know  their  own  powers,  the 
results  of  general  knowledge  of  all  men's  powers  may  be 
secured;  and  this  is  true  even  if  such  knowledge  is  (as  it  is 
in  fact)  very  imperfectly  or  not  at  all  communicable.  If 
those  who  furnish  productive  services  for  a  contractual 
remuneration  know  that  those  who  bid  for  the  services 
know  what  they  are  worth  to  themselves,  the  bidders,  or  if 
each  bidder  knows  this  to  be  true  of  the  others,  the  latter 
will  be  forced  to  pay  all  that  they  are  willing  to  pay,  which 
is  to  say  all  that  they  can  pay.  To  be  sure,  competition 
under  such  conditions  would  be  likely  to  take  on  the  char- 
acter of  a  poker  game,  a  bluffing  contest.  But  it  must  be 
admitted  that  actual  wage  bargains  are  in  no  slight  degree 
of  this  character. 

The  case  of  European  exploiters  among  primitive  peoples 
illustrates  the  possibility  of  large  profits  to  be  made  by  a 
small  number  of  men  who  know  what  they  are  doing 
among  a  large  number  who  do  not.  But  if  they  compete 
among  themselves  there  must  come  a  time,  if  their  number 
increases,  when  they  will  force  prices  to  their  competitive 
level  without  any  action  on  the  part  of  the  exploited 
masses  more  shrewd  than  that  of  accepting  a  larger  offer 
in  preference  to  a  smaller  one.  The  number  of  competitors 
required  to  bring  about  this  result  depends  upon  the  steep- 
ness of  the  curve  of  diminishing  returns  from  entrepreneur- 
ship,  upon  the  limitation  of  the  scope  of  enterprise  one  man 
can  deal  with  effectively.  And  the  idea  of  scope  must  be 
extended  to  include  the  variety  of  situations  to  be  dealt 
with.  The  question  of  diminishing  returns  from  entre- 
preneurship  is  really  a  matter  of  the  amount  of  uncertainty 
present.1  To  imagine  that  one  man  could  adequately  man- 

1  The  diminishing  returns  of  management  is  a  subject  often  referred 
to  in  economic  literature,  but  in  regard  to  which  there  is  a  dearth  of 


ENTERPRISE  AND  PROFIT  287 

age  a  business  enterprise  of  indefinite  size  and  complexity 
is  to  imagine  a  situation  in  which  effective  uncertainty  is 
entirely  absent. 

The  entire  foregoing  argument  has  dealt  with  a  simpli- 
fied situation  inasmuch  as  the  members  of  our  society  have 
been  assumed  to  know  something  about  the  true  value,  each 
of  his  own  judgment  and  ability  to  control  events  in  ac- 
cordance with  it,  but  to  know  these  things  about  each  other 
only  as  the  other  man's  own  opinion  of  himself  is  mani- 
fested in  his  dispositions  to  act.  In  fact  men  form  judg- 
ments of  other  men  on  the  basis  of  watching  their  perform- 
ances over  a  period  of  time,  and  in  addition  form  impres- 
sions having  some  claim  to  validity  from  mere  personal 
appearance,  conversation,  etc.  Such  knowledge  of  others 
is  one  of  the  most  important  factors  in  our  efforts  to  live 
together  intelligently  in  organized  society.  It  is  the  most 
difficult  to  discuss  scientifically  of  all  the  data  connected 
with  the  practical  bearings  of  knowledge  and  uncertainty. 

Estimates  of  the  worth  of  other  men's  opinions  and 
capabilities  probably  form  by  far  the  largest  part  of  the 
data  on  which  any  individual  makes  decisions  in  his  own 
life,  at  least  in  the  sphere  of  economic  activity  where  such 

scientific  discussion.  For  an  interesting,  but  in  the  present  writer's  view 
fundamentally  unsound,  treatment,  see  H.  C.  Taylor,  Agricultural 
Economics,  chap.  vi.  Our  own  discussion  of  the  theory  of  enterprise  is 
admitted  to  be  vague  and  unsatisfactory.  A  complete  and  logically  rigor- 
ous discussion  would  be  a  large  undertaking.  In  view  of  the  extreme  com- 
plexity of  the  elements  involved  in  uncertainty,  most  of  which  may  be  in- 
dependent variables,  the  number  of  possible  suppositions  which  might  be 
followed  out  is  prohibitive.  At  least  it  would  require  so  much  space  and  be 
so  difficult  to  follow,  and  of  so  little  practical  significance,  that  the  prob- 
ability of  its  being  read  does  not  justify  the  attempt.  It  is  hoped  that  the 
above  discussion  covers  the  principal  points  of  interest.  The  essential 
factors  are  men's  ability  in  the  entrepreneur  field,  which  includes  fore- 
sight and  executive  capacity,  and  their  knowledge  of  their  own  powers 
and  disposition  to  trust  them  in  action.  The  factors  likely  to  be  neglected 
are  the  last  two,  self-knowledge  and  self-confidence  or  initiative,  which  are 
closely  related,  but  not  identical.  In  addition,  knowledge  of,  and  willing- 
ness to  trust,  other  mens  powers  and  judgment  is  a  still  more  important 
consideration,  not  yet  discussed. 


/ 


288  RISK,  UNCERTAINTY,  AND  PROFIT 

activity  is  highly  organized.  Such  estimates  function  as  an 
indirect  indication  of  what  we  may  expect  to  happen  in  any 
set  of  conditions;  we  know  and  give  ourselves  credit  for 
knowing  nothing  of  value  about  the  problem  itself,  but  we 
know  what  is  the  belief  of  other  men  whose  judgment  we 
respect  and  which  we  accept  in  place  of  an  opinion  of  our 
own.  The  degree  of  confidence  which  we  feel  in  our  own 
situation  is  simply  the  degree  of  confidence  we  feel  in  the 
value  of  the  judgment  of  the  "authority  "  whose  pronounce- 
ment we  accept  as  the  best  information  available  on  the 
merits  of  the  case.  To  be  sure,  the  mode  of  formation  of 
these  opinions  of  others'  opinions  is  complex  and  obscure, 
and  is  rarely  free  from  all  passing  of  judgment  on  the  case 
itself  independently.  There  is  a  mutual  reinforcement;  we 
have  some  ideas  of  our  own  in  the  premises,  and  these  agree 
with  the  views  of  some  authority.  We  often  if  not  in  gen- 
eral believe  what  we  do  because  the  authority  believes  it, 
but  to  some  extent  we  believe  in  the  authority  because  he 
holds  the  view  to  which  we  were  already  inclined.  In  large 
measure  we  even  believe  in  ourselves  because  and  in  the 
measure  that  we  think  others  believe  in  us,  though,  on  the 
other  hand,  again,  .  .  .  But  it  is  enough  to  indicate  the 
complexity  of  the  relations  between  our  own  and  others' 
opinions  without  attempting  to  set  all  these  relations  out  in 
logical  statements.  The  importance  of  indirect  knowledge 
of  fact  through  knowledge  of  others'  knowledge  is  the  point 
we  wish  to  emphasize. 

Correspondingly,  the  uncertainty  of  the  knowledge  on 
the  basis  of  which  we  act  is  in  large  measure  the  margin  of 
error  in  our  estimates  of  the  authorities  whom  we  elect  to 
follow.  The  uncertainties  of  business  are  predominantly  of 
this  character,  and  the  genus  calls  for  particularly  careful 
study.  Our  discussion  hitherto  has  assumed  pure  and  un- 
divided entrepreneurship,  which  would  follow  from  the  im- 
possibility of  knowledge  by  one  person  of  another  person's 
capabilities.  In  the  absence  of  such  knowledge  it  is  clear 


ENTERPRISE  AND  PROFIT  289 

that  no  one  would  put  his  resources  under  the  direction  of 
another  without  a  valid  guarantee  of  the  payment  agreed 
upon,  and  no  one  could  become  an  entrepreneur  who  was 
not  in  a  position  to  make  such  guarantees  without  assis- 
tance,1 it  being  equally  clear  that  no  one  would  make  such 
a  guarantee  for  another.  That  is,  entrepreneurship  would 
be  completely  specialized  in  a  pure  form,  responsibility  and 
control  completely  associated.  When  men  have  knowledge, 
or  opinions  on  which  they  are  willing  to  act,  of  other  men's 
capacities  for  the  entrepreneur  function,  all  this  is  changed; 
entrepreneurship  is  no  longer  a  simple  and  sharply  isolated 
function.  This  is,  of  course,  the  state  of  affairs  in  real  life, 
and  it  is  this  partially  specialized  and  more  or  less  dis- 
tributed entrepreneurship  which  merits  most  careful  con- 
sideration. Several  forms  of  organization  and  modes  of 
distribution  of  the  function  call  for  notice. 

The  simplest  division  of  entrepreneurship  which  we  can 
think  of  is  the  separation  of  the  two  elements  of  control  and 
guarantee  and  their  performance  by  different  individuals. 
This  is  a  natural  arrangement,  for  it  must  often  happen 
that  entrepreneur  ability  will  not  be  associated  with  a  sit- 
uation on  the  part  of  its  possessor  enabling  him  to  make 
satisfactory  guarantees  of  the  contractual  incomes  prom- 
ised. Under  such  circumstances  it  may  be  mutually  profit- 
able for  him  to  enter  into  agreement  with  some  one  in  a 
position  to  underwrite  his  employment  contracts,  but  not 
himself  possessed  of  the  ability  or  disposition  to  undertake 
the  direction  of  enterprises.  The  form  of  this  partnership 
and  conditions  of  division  of  the  profit  may  be  highly  va- 
rious. As  a  matter  of  fact  we  know  that  it  commonly  takes 
the  shape  of  a  new  wage  bargain,  the  guarantor  hiring  the 

1  It  does  not  follow  that  he  would  have  to  own  property,  though  in  the 
real  world  this  is  the  practical  consequence.  It  is  easily  conceivable,  how- 
ever, that  one  might  secure  the  payment  of  his  obligations  by  pledging  his 
own  earning  power.  Such  an  arrangement  need  not  call  for  more  difficult 
feats  of  organization  or  involve  greater  strain  on  human  nature  than  is 
true  of  indemnity  insurance  at  present. 


290  RISK,  UNCERTAINTY,  AND  PROFIT 

director  in  much  the  same  way  as  the  latter  hires  the  pro- 
ductive services  which  he  organized  and  controls.  This 
transfer  of  function  involves  a  transformation  in  character 
also  which  must  be  considered  at  length,  and  will  be  taken 
up  in  the  next  chapter.  Let  us  note  here  that  it  is  usually 
impracticable  to  separate  all  the  guaranteeing  responsibility 
from  the  control  of  the  enterprise.  It  is  rare  that  a  hired 
entrepreneur  receives  a  contractual  income  as  his  only 
interest  in  the  business.  He  is  usually  a  part  owner,  or  at 
least  his  salary  is  so  adjusted  as  to  make  it  clear  that  his 
continuance  in  the  position  is  contingent  upon  its  pros- 
perity under  his  direction. 

An  effect  of  the  evaluation  of  ability  nearly  as  important 
as  the  transformation  in  entrepreneurship  with  its  partial 
transfer  to  another  individual  is  that  the  specialization  of 
the  function  within  the  enterprise  may  be  quite  incom- 
plete. That  is,  it  is  no  longer  true  that  men  are  necessarily 
unwilling  to  entrust  productive  services,  of  person  or 
property,  to  an  outsider  without  an  effective  material 
guarantee  of  the  fixed  payment  agreed  upon.  If  they  have 
confidence  in  the  manager's  ability  and  integrity  they  may 
gladly  work  with  only  a  partial  or  imperfect  security  for 
their  remunerations.  To  the  extent  that  this  is  the  case 
such  owners  of  productive  services  manifestly  share  in 
bearing  the  uncertainty  or  "taking  the  risk"  involved  in 
the  undertaking.  That  they  also  share  in  the  effective  con- 
trol will  appear  in  the  course  of  a  more  careful  examination 
of  the  entrepreneur  function  under  the  complicated,  vague, 
and  shifting  conditions  of  real  life  (except  that  progress  is 
still  abstracted),  which  is  the  next  stage  in  our  inquiry. 


CHAPTER  X 

ENTERPRISE  AND  PROFIT  (continued) 
THE  SALARIED  MANAGER 

The  typical  form  of  business  unit  in  the  modern  world  is 
the  corporation.  Its  most  important  characteristic  is  the 
combination  of  diffused  ownership  with  concentrated  con- 
trol.1 In  theory  the  organization  is  a  representative  democ- 
racy, of  an  indirect  type.  The  owners  elect  directors  whose 
main  function  is  to  choose  the  officials  who  are  said  actually  H 
to  carry  on  the  business  of  the  company.  The  directors 
themselves,  however,  exercise  real  direction  over  the  gen- 
eral policies  of  the  corporation.  Moreover,  if  it  is  a  large 
enterprise,  the  executive  officials  chosen  by  the  directors 
have  only  a  general  oversight  over  business  policy,  and 
their  chief  function  in  turn  is  to  select  subordinates  who 
make  most  of  the  actual  decisions  involved  in  the  control  of 
the  concern.  And  of  course  the  process  does  not  stop  there; 
there  may  be  many  stages  in  the  hierarchy  of  functionaries 
whose  chief  duties  consist  of  choosing  still  other  subordi- 
nates. 

The  first  necessary  step  in  understanding  the  distribution 
of  control  and  responsibility  in  modern  business  is  to  grasp 
this  fact:  What  we  call  "control"  consists  mainly  of 
selecting  some  one  else  to  do  the  "controlling."  Business 
judgment  is  chiefly  judgment  of  men.  We  know  things  by 
knowledge  of  men  who  know  them  and  control  things  in 

1  That  is,  the  most  important  characteristic  from  the  standpoint  of 
organization.  Of  perhaps  equal  importance  is  the  legal  nature  of  the  cor- 
poration as  an  entity  separate  from  its  member  owners.  The  term  "lim- 
ited liability"  is  not  descriptive.  The  members  of  a  corporation  have, 
strictly  speaking,  no  responsibility  at  all;  only  the  property  of  the  cor- 
poration, which  property  does  not  directly  belong  to  the  owners,  is  liable 
for  the  corporation's  obligations. 


292  RISK,  UNCERTAINTY,  AND  PROFIT 

the  same  indirect  way.  Nor  can  this  conclusion  be  escaped, 
as  there  is  some  tendency  to  pretend,  by  distinguishing 
between  judgment  of  ends  and  judgment  of  means.  The 
only  problems  with  which  we  have  any  concern  are  all 
problems  of  means.  There  is  only  one  end,  finally,  to 
business  activity,  and  this  is  already  decided  upon  before 
the  business  is  founded ;  that  is,  to  make  money.  The  de- 
cisions made  by  members  of  the  business  organization  all 
relate  to  means,  at  whatever  state  of  "generality"  they 
may  be  taken;  the  difference  between  decisions  as  to 
general  policy  and  operative  detail  is  one  of  degree  only, 
in  which  all  degrees  exist;  it  is  an  arbitrary  distinction. 
Decisions  as  to  ends  in  any  proper  sense  are  made  only  by 
consumers  —  persons  outside  the  productive  organization 
altogether. 

These  statements  hold  good  in  fact  for  all  other  de- 
partments of  organized  social  activity  as  well  as  for  busi- 
ness. They  are  even  more  true  of  political  organization. 
It  is  hardly  an  exaggeration  to  say  that  the  political  office- 
holder's business  is  to  get  the  job  and  then  find  some  one 
else  to  perform  its  duties.  In  the  field  of  organization,  the 
knowledge  on  which  what  we  call  responsible  control  de- 
pends is  not  knowledge  of  situations  and  problems  and  of 
means  for  effecting  changes,  but  is  knowledge  of  other 
men's  knowledge  of  these  things.  So  fundamental  to  our 
problem  is  this  fact  that  human  judgment  of  things  has  in 
an  effective  sense  a  "true  value"  which  can  be  estimated 
more  or  less  correctly  by  the  man  possessing  it  and  by 
others  —  so  fundamental  is  it  for  understanding  the  con- 
trol of  organized  activity,  that  the  problem  of  judging 
men's  powers  of  judgment  overshadows  the  problem  of 
judging  the  facts  of  the  situation  to  be  dealt  with.  And  if 
this  is  true  of  knowledge  it  is  manifestly  true  of  uncer- 
tainty. Under  organized  dealings  with  our  environment, 
attention  and  interest  shift  from  the  errors  in  men's  opin- 
ions of  things  to  the  errors  in  their  opinions  of  men.  Or- 


ENTERPRISE  AND  PROFIT  293 

ganized  control  of  nature  in  a  real  sense  depends  less  on  the 
possibility  of  knowing  nature  than  it  does  on  the  possibility 
of  knowing  the  accuracy  of  other  men's  knowledge  of 
nature,  and  their  powers  of  using  this  knowledge. 

The  fundamental  principle  underlying  organized  activity 
is  therefore  the  reduction  of  the  uncertainty  in  individual 
judgments  and  decisions  by  grouping  the  decisions  of  a 
particular  individual  and  estimating  the  proportion  of 
successes  and  failures,  or  the  average  quality  of  his  judg- 
ments as  a  group.  It  is  an  application  of  the  broader  prin- 
ciple of  consolidation  of  risks,  but  the  circumstances  are 
peculiar.  The  result  can  never  be  calculated,  either  from 
a  priori  data  or  from  tabulations  of  instances  observed.  It 
is  an  estimate  in  the  purest  sense,  an  estimate  into  which 
previous  observation  may  enter  little.  We  form  our  opin- 
ions of  the  value  of  men's  opinions  and  powers  through  an 
intuitive  faculty  of  judging  personality,  with  relatively 
little  reference  to  observation  of  their  actual  performance 
in  dealing  with  the  kind  of  problems  we  are  to  set  them  at. 
Of  course  we  use  this  sort  of  direct  evidence  as  far  as  possi- 
ble, but  that  is  usually  not  very  far.  The  final  decision 
comes  as  near  to  intuition  as  we  can  well  imagine;  it 
constitutes  an  immediate  perception  of  relations,  as  mys- 
terious as  reading  another  person's  thoughts  or  emotions 
from  subtle  changes  in  the  lines  of  his  face. 

The  great  complexity  and  difficulty  in  the  analysis  of 
business  uncertainty  and  of  profit  as  the  remuneration 
connected  with  meeting  it  arises  from  this  peculiar  dis- 
tribution of  responsibility  in  the  organization.  There  is  an 
apparent  separation  of  the  functions  of  making  decisions 
and  taking  the  "risk"  of  error  in  decisions.  The  separa- 
tion appears  quite  sharp  in  the  case  of  the  hired  manager, 
as  in  a  corporation,  where  the  man  who  makes  decisions 
receives  a  fixed  salary,  taking  no  "risk,"  and  those  who 
take  the  risk  and  receive  profits  —  the  stockholders  — 
make  no  decisions,  exercise  no  control.   Yet  a  little  exami- 


294  RISK,  UNCERTAINTY,  AND  PROFIT 

nation  in  the  light  of  the  preceding  discussion  of  indirect 
knowledge  and  indirect  responsibility  will  show  that  the 
separation  is  illusory;  when  control  is  accurately  defined 
and  located,  the  functions  of  making  decisions  and  assum- 
ing the  responsibility  for  their  correctness  will  be  found  to 
be  one  and  indivisible. 

The  phenomena  can  be  best  elucidated  by  beginning  at 
the  very  "bottom"  of  the  scale,  with  the  "routine"  duties 
of  the  common,  unskilled  laborer.  It  will  be  evident  on 
reflection  that  even  the  coarsest  and  most  mechanical 
labor  involves  in  some  sense  meeting  uncertainty,  dealing 
with  contingencies  which  cannot  be  exactly  foreseen.  It 
seems  to  be  the  function  of  all  conscious  life  to  deal  with 
"new  situations."  Consciousness  would  never  have  devel- 
oped if  the  environment  of  living  organisms  were  perfectly 
uniform  and  monotonous,  conformable  to  mechanical  laws. 
In  such  a  world  organisms  would  be  automata.  There  is  a 
manifest  tendency  to  economize  consciousness,  to  make  all 
possible  adaptations  by  unconscious  reflex  response.  In 
human  life  we  see  complex  adaptations  such  as  performing 
on  a  musical  instrument  drop  below  the  threshold  when 
learned.  If  the  requisite  movements  were  constant  from 
generation  to  generation  there  is  little  -doubt  that  they 
would  become  fixed  in  the  germ  plasm  by  the  slow  process 
of  natural  selection  if  we  eliminate  the  more  direct  method 
by  inheritance  of  acquired  characters. 

Moreover,  in  industrial  life,  purely  routine  operations 
are  inevitably  taken  over  by  machinery.  The  duties  of 
the  machine  tender  may  seem  mechanical  and  uniform, 
but  they  are  really  not  so  throughout  the  operation.  His 
function  is  to  complete  the  carrying-out  of  the  process  to 
the  point  where  it  becomes  entirely  uniform  so  that  the 
machine  can  take  hold  of  it,  or  else  to  begin  with  the 
uniform  output  of  the  machine  and  start  it  on  the  way 
of  diversification.  Some  part  of  the  task  will  practically 
always  be  found  to  require  conscious  judgment,  which  is 


ENTERPRISE  AND  PROFIT  295 

to  say  the  meeting  of  uncertainty,  the  exercise  of  respon- 
sibility, in  the  ordinary  sense  of  these  terms. 

But  from  the  standpoint  of  organization  the  work  of 
the  common  laborer  does  not  involve  uncertainty  or  re- 
sponsibility in  the  effective  sense,  on  account  of  the  prin- 
ciple of  indirect  knowledge  and  transfer  of  responsibility 
discussed  above.  Even  when  it  is  impossible  to  reduce 
the  work  itself  to  routine  sufficiently  for  a  machine  to 
handle  it  —  due  usually  to  lack  of  uniformity  (i.e.,  un- 
certainty) in  the  material  worked  with  —  it  is  possible  to 
judge  with  a  high  degree  of  accuracy  the  capacity  of  a 
human  individual  to  deal  with  the  sort  of  irregularities  to 
be  met  with  in  the  occupation.  It  is  the  function  of  the 
operative  in  industry  to  deal  with  uncertainty  as  a  matter 
of  routine !  The  exact  movements  he  shall  have  to  perform 
cannot  be  foretold,  but  his  ability  to  perform  them  can 
be,  and  so  the  uncertainty  is  eliminated  as  an  element  in 
the  calculations;  ignorance  of  the  environmental  situation 
gives  place  to  knowledge  of  human  judgment. 

The  contrast  again,  even  in  case  of  the  humblest  opera- 
tive, is  not  absolute.  Most  such  persons  occasionally 
meet  with  contingencies  in  regard  to  which  they  are  ex- 
pected to  appeal  to  judgment  and  ability  superior  to  their 
own.  Nor  can  the  operative's  ability  to  handle  his  job  be 
known  with  complete  accuracy  to  his  superior.  The  opera- 
tive must  exercise  judgment  over  his  own  capacities  in 
knowing  when  to  go  ahead  independently  and  when  to  ap- 
peal for  guidance.  And  the  official  who  assigns  the  opera- 
tive to  his  job  and  fixes  his  remuneration  for  performing  it 
must  exercise  a  rather  higher  quality  of  judgment  in  es- 
timating the  powers  of  the  operative.  The  net  effect  is  that 
uncertainty  and  responsibility  are  not  quite  eliminated, 
but  are  partially  transferred  to  the  superior  in  the  scale  of 
organization.  The  true  uncertainty  in  the  case  relates  to 
this  official's  judgment  of  his  man  in  relation,  of  course,  to 
the  position  he  is  to  fill.  As  far  as  the  lowest  man  in  the 


296  RISK,  UNCERTAINTY,  AND  PROFIT 

scale  is  concerned,  he  is  freed  from  all  responsibility  be- 
yond the  ("routine")  duty  of  using  his  best  judgment  as 
occasion  requires.  His  superior  is  responsible  for  him,  and 
he  accordingly  receives  a  fixed  wage.1 

It  will  already  be  clear  that  this  process  of  transferring 
responsibility  does  not  end  with  the  first  step  at  the  bottom 
of  the  scale,  and  the  goal  to  which  the  argument  will  lead 
is  in  fairly  plain  view.  The  foreman  (let  us  say)  who  passes 
judgment  on  the  abilities  of  operatives  and  takes  the  re- 
sponsibility for  their  performing  in  accordance  with  his  ex- 
pectations finds  himself  in  turn  in  a  similar  relation  to  his 
own  ranking  superior  in  the  organization.  His  capacity  to 
judge  operatives  is  passed  upon  and  reduced  to  a  routine 
function  in  the  same  way  that  he  passes  upon  their  capaci- 
ties to  do  their  work,  and  likewise  his  capacity  to  deal  with 
those  more  exceptional  contingencies  in  which  operatives 
are  likely  to  appeal  to  hifti;  and  his  responsibility  is  in  turn 
transferred  to  the  higher  official  (superintendent  or  what- 
not) who  selects  him,  assigns  him  to  his  work,  and  hears 
appeals  in  those  still  rarer  questions  which  he  refers  higher 
up  for  decision.  The  knowledge  on  which  the  higher  con- 
trol is  based  is  again,  and  still  more,  knowledge  of  a  man's 
capacity  to  deal  with  a  problem,  not  concrete  knowledge  of 
the  problem  itself.  The  higher  official  may  in  fact  be  very 
competent  to  deal  with  the  problem  directly,  but  he  does 
not  do  so.  And  it  is  noteworthy  that  he  may  not  be  com- 
petent in  this  sense.  Some  superintendents  would  doubt- 
less make  better  foremen  than  their  foremen,  and  only 
serve  in  the  higher  capacity  because  of  the  still  greater 

1  It  need  hardly  be  pointed  out  that  the  principle  of  consolidation  of 
risks  is  operative  here  to  a  certain  extent.  The  employer  of  men  passes 
judgment  on  their  "average"  competency  to  do  the  things  that  they  are 
expected  to  do,  an  average  in  the  case  of  each  individual  and  an  average 
involving  a  further  canceling-out  of  errors  if  he  selects  a  number  of  em- 
ployees. A  still  higher  order  of  responsible  judgment  is  involved  in  laying- 
out  and  subdividing  the  work  of  the  establishment  so  that  the  task  of 
each  single  employee  is  adapted  to  a  certain  fairly  uniform  grade  of 
ability. 


ENTERPRISE  AND  PROFIT  297 

rarity  and  value  of  the  ability  to  judge  and  handle  fore- 
men. But  it  is  unquestionable  that  a  great  many  men  make 
very  good  superintendents  who  would  not  make  good  fore- 
men at  all,  and  perhaps  this  is  the  more  common  case. 

On  up  the  scale  the  same  relations  hold  good  until  we 
come  to  the  supreme  head  of  the  business.  For  simplicity 
we  may  suppose  that  this  individual  combines  all  the 
managerial  functions  in  his  single  person,  that  he  is  presi- 
dent, general  manager,  and  so  forth,  that  his  directors 
exercise  no  control  over  him  whatever  beyond  giving  him 
his  place  and  salary  and  a  perfectly  free  hand.  Even  such 
an  individual  is  in  a  position  similar  in  essential  respects,  as 
far  as  the  problem  of  organization  is  concerned,  to  that  of 
the  lowly  machine  tender.  His  capacities  to  deal  with  the 
kind  of  situations  he  has  to  deal  with  are  subject  to  evalua- 
tion, are  evaluated.  His  work  is  also  a  "routine"  task  of 
exercising  his  best  judgment  —  and  leaving  the  conse- 
quences to  others.  The  real  responsibility  is  again  shifted 
back,  as  the  effective  uncertainty  is  in  the  judgment  which 
placed  him  in  his  position.  The  responsible  decision  is  not 
the  concrete  ordering  of  policy,  but  ordering  an  orderer  as  a 
"laborer"  to  order  it.  And  this  final  responsibility  necessa- 
rily takes  the  consequences  of  its  decisions.  The  apparent 
separation  between  control  and  risk  taken  turns  out,  as 
predicted,  to  be  illusory.  The  paradox  of  the  hired  mana- 
ger, which  has  caused  endless  confusion  in  the  analysis  of 
profit,  arises  from  the  failure  to  recognize  the  fundamental 
fact  that  in  organized  activity  the  crucial  decision  is  the 
selection  of  men  to  make  decisions,  that  any  other  sort  of 
decision-making  or  exercise  of  judgment  is  automatically 
reduced  to  a  routine  function.  All  of  which  follows  from 
the  very  nature  of  large-scale  control,  based  on  the  re- 
placement of  knowledge  of  things  by  knowledge  of  men, 
as  our  analysis  has  shown. 

We  must  refuse  to  be  misled  by  the  superficial  similarity 
between  the  daily  work  of  the  hired  manager  and  that  of 


298  RISK,  UNCERTAINTY,  AND  PROFIT 

the  man  in  business  on  his  own  account.  The  difference  is 
far  more  fundamental.  The  former  has  had  his  task  cut 
out  for  him  by  others  and  been  set  to  perform  it;  the  latter 
has  cut  out  his  own  task  to  fit  his  own  measure  of  himself, 
and  set  himself  at  it.  Here  is  the  really  responsible  decision, 
made  for  the  hired  manager,  by  the  independent  enter- 
priser. Whenever  we  find  an  apparent  separation  between 
control  and  uncertainty-bearing,  examination  will  show 
that  we  are  confusing  essentially  routine  activities  with 
real  control.1 

Like  a  large  proportion  of  the  practical  problems  of 
business  life,  as  of  all  life,  this  one  of  selecting  human  capaci- 
ties for  dealing  with  unforeseeable  situations  involves  para- 
dox and  apparent  theoretical  impossibility  of  solution.  But 
like  a  host  of  impossible  things  in  life,  it  is  constantly  being 
done.  Though  we  cannot  anticipate  a  concrete  situation 
accurately  enough  to  meet  it  without  the  intervention  of 
conscious  judgment  at  that  moment,  it  can  be  foreseen  that 
under  certain  circumstances  the  kind  of  things  that  will 
turn  up  will  be  of  a  character  to  be  dealt  with  by  a  kind  of 
capacity  which  can  be  selected  and  evaluated.  That  large- 
scale  organizations  are  formed  and  operate  successfully 
demonstrates  that  this  principle  is  sound,  that  for  these 
impossible  problems  solutions  more  right  than  wrong  are 
actually  found.  Partly  through  operation  of  the  principle 
of  reduction  of  uncertainty  by  consolidation,  partly  for 
reasons  embodied  in  our  faculties  of  interpreting  personal- 
ity and  which  seem  to  be  inscrutable,  knowledge  of  men's 
capacities  to  know  turns  out  to  be  more  accurate  than 
direct  knowledge  of  things. 

Another  phase  of  entrepreneurship  based  on  the  same 

fundamental  facts  of  transfer  of  responsibility,  and  which 

still  further  complicates  its  analysis,  is  the  incompleteness 

1  Cf.  Hawley's  contention  {Quarterly  Journal  of  Economics,  vol.  xv, 
p.  88)  that  the  hired  manager  makes  decisions,  but  the  enterpriser  takes 
the  consequences  of  decisions,  and  that  the  former  is  therefore  not  an 
enterpriser. 


ENTERPRISE  AND  PROFIT  299 

of  specialization.  We  may  introduce  the  problem  as  a 
continuation  of  the  above  argument  by  inquiring  into  the 
question,  To  whom  is  the  responsibility  ultimately  trans- 
ferred when  the  entire  conduct  and  policy  of  a  business  are 
in  the  hands  of  a  hired  manager?  The  answer  is  obvious: 
to  the  owners  of  the  productive  services  used  in  the  busi- 
ness; i.e.,  to  the  very  shoulders  from  which  the  same  re- 
sponsibility is  taken  in  the  case  of  the  specialization  of  func- 
tion involved  in  contracting  with  an  independent  entre- 
preneur. In  the  latter  case  the  entrepreneur,  who  selects 
himself,  takes  over  all  the  uncertainty  of  the  business  along 
with  control  over  it.  But  in  view  of  the  difficulty  of  any 
single  individual  giving  adequate  security  for  the  perfor- 
mance of  his  contracts  in  the  case  of  a  large  undertaking, 
such  a  form  of  organization  has  a  very  limited  opportunity 
for  growth.  For  it  is  clear  that  only  the  possessor  of  trans- 
ferable wealth  already  produced  (consumers'  or  producers' 
goods)  or  of  future  productive  capacity  in  some  form  can 
make  guarantees  or  really  bear  uncertainty  or  take  risks  for 
other  persons.  And  it  is  nearly  inevitable  that  the  man  who 
"undertakes"  any  line  of  business  as  entrepreneur  will 
commit  a  part  of  his  own  wealth  or  productive  powers  to 
that  business.  What  naturally  happens,  then,  in  any  case  is 
that  the  control  of  enterprise  falls  into  the  hands  of  the 
owner  (or  owners)  of  a  part  of  the  productive  services 
used  in  the  enterprise,  which  resources  are  placed  in  an 
exposed  position  with  regard  to  losses  in  the  business  and 
so  guarantee  the  owners  of  the  remaining  "land,  labor,  and 
capital"  against  failure  to  receive  their  full  contractual 
remuneration. 

It  is  impossible  for  entrepreneurship  to  be  completely 
specialized  or  exist  in  a  pure  form,  except  in  the  rare  and 
improbable  case  of  a  man  who  owns  nothing  in  a  particular 
business  and  contributes  nothing  to  it  but  responsibility. 
Even  a  man  who  conducted  a  business  entirely  with  bor- 
rowed funds  and  hired  labor,  but  managing  it  himself,  would 


300  RISK,  UNCERTAINTY,  AND  PROFIT 

not  exemplify  pure  entrepreneurship,  for  a  large  part  of 
the  work  of  management  is  as  we  have  seen  reducible  to 
routine  and  can  be  paid  for  with  a  fixed  wage.  The  nearest 
approach  to  an  entrepreneur  only  would  be  a  man  who 
borrowed  all  the  resources  for  operating  a  business  and  then 
hired  a  manager  and  gave  him  an  absolutely  free  hand. 
And  such  a  man  would  have  to  be  more  than  an  entre- 
preneur in  relation  to  some  other  business,  or  he  would  not 
be  a  true  entrepreneur,  making  responsible  decisions,  in 
the  business  in  question. 

-  The  natural  result  is  a  complicated  division  or  diffusion 
of  entrepreneurship,  distributed  in  the  typical  modern 
business  organization  by  a  hierarchy  of  security  issues 
carrying  every  conceivable  gradation  and  combination  of 
rights  to  control  and  to  freedom  from  uncertainty  as  to  in- 
come and  vested  capital.  The  feature  of  the  system  apt  to 
be  overlooked  is  a  large  element  of  real  control  disguised 
under  a  nominal  contract  for  a  fixed  return.  It  is  seldom 
true  that  the  guarantees  given  can  be  regarded  as  absolute. 
If  they  are  not,  the  owner  of  resources  is  taking  a  certain 
share  of  responsibility  or  risk,  obviously.  That  he  is  also 
exercising  control  becomes  apparent  if  we  consider  that  his 
decision  to  allow  the  use  of  his  labor  or  property  under  the 
conditions  affects  the  scale  of  operations  of  the  business. 
Control  is  completely  absent  from  the  function  of  furnish- 
ing productive  services  to  a  business  only  in  case  an  ac- 
curately determined  competitive  value  of  the  services  is 
effectively  guaranteed,  so  that  everything  but  the  money 
remuneration  is  made  completely  indifferent  to  their 
owner. 

As  a  matter  of  fact  we  know  that  it  is  common  for  those 
who  furnish  resources  to  an  enterprise  to  retain  a  large 
amount  of  direct  consultative  authority  in  regard  to  the 
conduct  of  the  business.  The  voting  trust  is  a  device  for 
securing  this  end  and  owes  its  importance  to  the  necessity 
of  providing  for  security  owners  an  assurance  of  competent 


ENTERPRISE  AND  PROFIT  SOI 

control  when  adequate  protection  of  their  interests  cannot 
otherwise  be  achieved,  especially  when  the  value  of  the 
property  depends  largely  on  its  intelligent  employment  in 
the  particular  use  to  which  it  has  been  committed.  With 
the  increasing  specialization  of  industry  such  conditions 
become  more  and  more  common,  effective  guarantees 
become  harder  and  harder  to  make,  and  investors  find  it 
necessary  to  insist  more  and  more  on  sharing  in  the  control 
of  business.  The  distinction  between  stocks  and  bonds 
tends  to  fade  out.1  It  is  hard  to  find  an  illustration  of  an 
unconditional  transfer  of  productive  resources  to  a  business 
for  its  use  for  a  pecuniary  consideration  alone  without  an 
outright  transfer  of  ownership.  The  owners  of  limited 
issues  of  first-mortgage  bonds  have  an  ultimate  recourse  to 
the  courts  to  compel  honest  management  of  the  concern  if 
their  interests  are  jeopardized.  Only  in  such  a  case  as  the 
lease  of  pure  site  value  which  is  indestructible  and  not 
changed  in  any  way  by  use  can  we  find  an  example  of 
an  income  entirely  freed  from  the  element  of  responsible 
control. 

The  case  of  labor  is  somewhat  peculiar,  owing  to  the 
disposition  of  laboring  people  to  gamble  recklessly  with  life 
and  limb  as  well  as  income.  Under  free  competition  there 
is  little  doubt  that  a  considerable  proportion  of  the  losses 
of  enterprise  would  fall  upon  labor,  since  laborers  show 
themselves  ready  to  engage  in  hazardous  enterprises  at 
their  own  risk  for  an  increase  in  wages  which  is  a  fraction  of 
an  adequate  compensation  for  the  chances  they  take.  But 
the  social  interest  in  the  man  who  cannot  afford  the  loss 
comes  to  the  rescue  with  prior  claim  laws,  mechanics'  liens, 

1  Of  course,  the  machinery  by  which  control  is  exercised  becomes  more 
indirect  and  the  control  itself  more  remote.  Stocks  approximate  to  the 
real  position  of  bonds  as  well  as  bonds  to  that  of  stocks.  One  form  of  the 
change  is  a  tendency  to  cover  a  larger  proportion  of  investment  by  stock 
issues  (as  compared  with  bonds)  than  formerly.  The  increased  recourse 
to  borrowing  from  banks  shows  the  same  tendency,  for  banks  in  particular 
keep  in  touch  with  the  management  of  businesses  in  which  they  invest. 


302  RISK,  UNCERTAINTY,  AND  PROFIT 

and  the  like,  so  that  the  wages  of  labor  are  in  fact  generally 
a  fair  approximation  to  a  guaranteed  contractual  return. 
The  element  of  control  which  would  be  involved  in  a  de- 
pendence of  business  upon  laborers'  choice  of  the  ventures 
they  would  engage  in,  is  correspondingly  absent,  as  the 
effective  contracting-out  of  the  risk  places  different  lines  of 
employment  on  a  plane  of  indifference  at  the  wages  fixed.1 
The  relations  between  profit  and  the  contractual  shares 
call  for  a  few  further  remarks.  As  observed  in  our  histori- 
cal introduction  (chapter  n)  the  older  English  economists 
used  the  term  "profit "  to  designate  the  income  of  the 
owner  of  a  business,  who  was  regarded  as  essentially  an 
investor.  Hence,  as  the  classical  economics  was  essentially 
a  long-time  theoretical  treatment,  little  distinction  was 
drawn  between  profit  and  interest.  A  wage  element  was 
recognized  in  the  income,  and  also  a  risk  factor.  Little 
was  made  of  the  latter  as  constituting  a  distinction  between 
profit  and  interest,  as  ordinary  contract  interest  so  ob- 
viously contains  an  element  of  payment  for  risk  also. 
And  in  view  of  our  argument  above  that  the  assumption  of 
risk  in  this  connection  involves  the  exercise  of  effective 
control  to  the  same  extent,  the  relegation  of  this  factor  into 
the  background  is  still  further  justified. 

1  The  case  of  the  ultimate  entrepreneur,  dealing  with  and  knowing 
men  rather  than  things,  suggests  again  the  analogous  political  problem. 
The  progress  of  democracy  toward  intelligent  efficiency  seems  to  depend 
on  a  tendency  for  the  ultimate  sovereign,  the  electorate,  to  center  its 
attention  on  the  selection  of  competent  agents,  leaving  to  them  the  actual 
formulation  of  policies  and  conduct  of  affairs.  Commission  government, 
and  still  more  the  manager  plan  of  municipal  government,  is  a  case  in 
point.  In  the  political  sphere  there  is  a  real  problem  of  ultimate  ends, 
which  must,  of  course,  be  dealt  with  by  the  electorate  if  the  system  re- 
mains democratic.  And  perhaps  more  than  in  the  case  of  business  the 
voter's  judgment  of  the  candidate  must  be  connected  with  passing  an 
opinion  upon  the  issues,  partly  because  major  issues  to  some  extent  in- 
volve a  question  of  ultimate  social  ideals.  Professor  Cooley  (Social  Or- 
ganization, p.  129  and  chap,  xiii)  bases  an  optimistic  view  of  democracy 
on  a  belief  in  the  capacity  of  the  populace,  admittedly  ignorant  in  regard 
to  political  issues  and  the  technique  of  government,  to  select  men  wisely 
on  the  basis  of  a  sort  of  intuitive  recognition  of  personal  superiority. 


ENTERPRISE  AND  PROFIT  303 

American  economic  discussion  developed  under  the  in- 
fluence of  the  marginal  utility  theory,  which  is  essentially  a 
short  time  view  of  the  valuation  problem.  There  is  some 
connection  between  this  fact  and  the  greater  emphasis 
given  in  this  country  to  "wages  of  management"  and  the 
separation  of  this  element  from  the  entrepreneur's  income, 
leaving  "profit"  or  "pure  profit"  in  a  narrower  sense 
than  that  given  the  term  by  the  older  writers.  For  man- 
agement is  more  conspicuous  in  American  industry,  due  to 
the  more  "dynamic"  conditions  of  this  country.  In  a  long- 
time view  or  "static  state"  it  would  be  relatively  much 
less  important.  The  greater  emphasis  given  the  risk  factor 
in  American  (as  in  German)  discussions  is  explained  in  the 
same  way,  a  more  dynamic  background  and  greater  in- 
terest in  short-period  changes. 

With  the  recent  development  of  accounting  theory,  the 
question  whether  interest  on  investment  should  be  counted 
in  profit  has  become  acute  from  another  point  of  view  and 
has  tended  to  constitute  an  issue  between  accountants  and 
economic  theorists.  This  is  of  course  entirely  uncalled-for, 
as  the  difference  in  position  is  a  matter  of  obvious  differ- 
ence in  standpoint.  Economic  theory  is  interested  in  the 
forces  which  determine  the  prices  of  goods,  and  in  costs 
of  production  as  a  condition  of  supply.  It  goes  without 
saying  that,  in  the  long  run  again,  a  return  on  capital  equal 
to  the  competitive  rate  of  interest  is  a  condition  of  produc- 
tion, and  so  from  this  point  of  view  a  cost.  (That  things 
may  be  different  from  a  short-time  viewpoint  serves  to 
increase  the  confusion.)  The  accountant  is  interested  in 
proprietorship,  the  relations  between  a  business  and  its 
owners,  and  in  cost  as  a  deduction  from  the  owner's  in- 
come. Moreover,  scientific  accounting  is  an  outgrowth  of 
corporation  problems,  and  in  the  corporation  the  responsi- 
ble owner  is  thought  of  as  an  investor,  his  interest  as  a 
capital  interest,  whether  he  has  put  any  money  in  the 
business  or  not  and  whether  or  not  it  has  any  value  above 


304  RISK,  UNCERTAINTY,  AND  PROFIT 

its  debts.  And  profit,  being  a  return  on  investment,  is 
naturally  thought  of  as  a  rate  of  return. 

In  most  cases  it  would  not  be  fruitful  to  attempt  an 
accurate  separation  of  profit  from  interest.1  For  on  the 
other  side  of  the  relation,  pure  interest  is  almost  as  rare  a 
phenomenon  and  as  elusive  a  concept  as  pure  profit.  The 
specialization  of  the  entrepreneur  function  is  a  fundamental 
fact  in  business  organization,  but  for  reasons  which  should 
already  bejglear,  it  cannot  be  carried  to  theoretical  com- 
pleteness. The  entrepreneur  must  almost  of  necessity  own 
some  property  and  the  owner  of  property  used  in  a  busi- 
ness can  hardly  be  freed  from  all  risk  and  responsibility. 
It  is  useful,  however,  to  distinguish  between  the  return 
actually  realized  by  an  entrepreneur  and  the  "  competitive  " 
rate  of  interest  on  high-class  "gilt-edge"  securities  where 
the  risk  and  responsibility  factor  is  negligible.  The  differ- 
ence would  be  profit,  or  "pure  profit"  in  the  sense  in  which 
economic  theory  uses  the  term. 

Even  at  last  some  reservation  must  be  made  in  calling 
interest  on  the  entrepreneur's  investment  a  cost  of  pro- 
ducing the  commodity.  It  is  generally  admitted  that  if 
this  rate  of  return  is  not  realized  on  the  average  and  in  the 
long  run  the  investment  will  not  be  held  in  the  business  in 
question.  But  the  truth  accurately  stated  evidently  is  that 
the  owner  must  expect  in  the  future  to  receive  a  return  equal 
to  that  which  he  can  be  sure  of  elsewhere,  on  the  invest- 
ment which  he  is  free  to  transfer  to  other  uses.  And  of  course 
allowance  must  be  made  for  the  connection  between  differ- 
ent elements  of  investment  as  well  as  technological  fluidity. 
If  half  the  investment  in  an  enterprise  represents  machin- 
ery, working-capital,  land,  or  what-not  which  can  be  trans- 

1  By  "interest"  is  here  meant  property  income  merely.  The  relation 
between  interest  and  rent  is  essentially  a  "dynamic"  problem,  and  will  be 
taken  up  for  discussion  in  the  following  chapter.  It  is  questionable 
whether  interest  would  be  met  with  at  all  in  an  unprogressive  society,  and 
certain  that  the  distinction  between  interest  and  rent  would  be  of  small 
importance.  Cf .  also  above,  chapter  v. 


ENTERPRISE  AND  PROFIT  305 

ferred  to  other  lines,  and  the  other  half  represents  perma- 
nent commitment,  worthless  outside  the  particular  busi- 
ness, the  cost  of  producing  the  output  of  that  business 
(after  the  commitment  has  been  made)  is  only  the  (antici- 
pation of  the)  competitive  return  on  the  removable  half 
of  the  capital  alone.  Of  course  this  half  could  not  be  re- 
moved without  rendering  the  remainder  worthless. 

The  association  of  profit  with  income  on  property  is 
valid,  within  the  limits  discussed,  for  the  greater  part  of 
business  enterprises,  but  there  are  important  exceptions. 
The  independent  entrepreneur  is  not  yet  by  any  means 
an  extinct  species.  Such  a  person  typically  furnishes  both 
property  and  labor  services  to  a  business,  meaning  by  labor 
services  personal  activities  which  might  be  hired  and  paid 
for  with  a  fixed  wage.  The  entrepreneur  income  in  a  case 
of  this  sort  contains  an  element  of  wages  as  well  as  an 
element  of  interest.  The  contention  of  some  accountants 
that  a  salary  should  be  allowed  for  the  owner's  work  and 
the  residue  considered  as  a  return  on  his  investment  does 
not  seem  to  be  well  founded.  It  is  based  on  a  bias  derived 
from  the  habitual  (and  proper)  procedure  in  corporations, 
where  the  responsible  owner  furnishes  property  services 
only.  It  would  be  just  as  logical  to  deduct  from  the  owner's 
income  a  competitive  rate  of  interest  and  call  the  residue 
wages  or  wages  of  management.  The  only  significant  dis- 
tinction is  that  between  the  total  income  and  a  "pure  pro- 
fit" secured  by  deducting  both  competitive  wages  for  the 
work  and  competitive  interest  on  the  investment  furnished 
by  the  owner.  The  determination  of  the  proper  wage  rate 
will  be  fraught  with  the  same  sort  of  difficulties  that  have 
been  referred  to  in  the  case  of  pure  interest,  but  in  a  much 
more  aggravated  form;  it  is  far  more  difficult  to  appraise 
labor  and  find  similar  services  in  the  competitive  field  as 
a  basis  of  comparison  than  in  the  case  of  property.1 

1  We  must  again  refer  to  the  use  of  the  term  "interest"  as  meaning 
property  income  merely,  though  superficially  this  is  not  quite  consistent 


306  RISK,  UNCERTAINTY,  AND  PROFIT 

In  some  instances,  though  perhaps  a  relatively  small 
proportion  of  real  enterprises  and  those  probably  of  small 
average  size,  the  independent  entrepreneur  may  have  no 
property  investment  in  his  business,  furnishing  labor 
services  only.  It  is  in  reference  to  such  a  situation  that  the 
conventional  (American)  treatment  of  profit  and  wages  of 
management  has  most  significance.  It  must  be  very  un- 
usual, for  reasons  already  pointed  out,  for  a  man  to  hire 
the  use  of  the  labor  and  property  of  others  without  putting 
up  some  property  as  well  as  labor  of  his  own.  It  would  be 
possible,  within  limits,  for  such  a  man  to  give  adequate 
security  for  payment  of  the  fixed  remuneration  of  outside 
agencies,  if  his  own  earning  capacity  were  high.1 

But  in  reality  this  probably  does  not  happen  on  any 
considerable  scale,  or  with  enterprises  of  large  magnitude. 
However,  allowance  must  be  made  for  the  ownership  of 
property  used  in  other  enterprises,  and  also  for  the  "moral 
backing"  of  wealthy  relatives  or  friends.  And  such  "moral 
backing  "  may  or  may  not  constitute  a  division  of  the  entre- 
preneur's responsibility.  The  only  ultimate  security  may 
still  be  the  potential  earning  power  of  the  entrepreneur 
himself,  which,  however,  might  not  be  marketable  on  ac- 
count of  a  moral  hazard  without  being  underwritten  by 
property-owning  connections. 

On  the  whole  we  must  say  that  the  discussion  of  profit 
in  relation  to  wages  of  management  has  been  greatly  over- 
worked. The  connection  with  property  income  is  enor- 
mously more  common,  direct,  and  close.  The  residual  share 
of  income  falls  of  necessity  to  the  person  in  responsible  con- 
trol of  a  business;  hence,  in  most  cases  to  a  person  who  also 
receives  a  property  income.  He  may  or  may  not  also  receive 

with  treatment  of  it  as  a  "rate."  Pure  interest  is  much  more  easily  de- 
fined than  a  pure  competitive  return  on  actual  property,  but  even  the 
latter  offers  less  difficulty  than  an  appraisal  of  the  competitive  value  of 
the  services  of  an  independent  entrepreneur. 

1  To  the  extent  that  he  does  not  give  adequate  security  the  owners  of 
the  productive  services  exposed  to  loss  are  the  true  entrepreneurs. 


ENTERPRISE  AND  PROFIT  307 

a  labor  income  as  well.  The  important  distinction  for  the 
purposes  of  theoretical  analysis  is  that  between  pure  resid- 
ual income  or  pure  profit  and  property  income.  The  rela- 
tion to  labor  income  is  incidental  in  importance  compara- 
tively, and  being  of  the  same  character,  at  any  rate,  does 
not  call  for  much  space  in  a  discussion  of  profit.  If  a  dis- 
tinction is  made  between  land  and  capital,  it  must  be  recog- 
nized that  the  profit  receiver  may  be  also  a  recipient  of  rent, 
in  addition  to  interest  or  wages  or  both.  And  in  exceptional 
cases  he  may  receive  rent  only,  as,  for  instance,  a  farmer 
who  owns  his  land,  but  borrows  all  his  working  capital  and 
hires  all  his  work  done.  In  such  a  case  the  practical  prob- 
lem would  be  to  distinguish  pure  profit  from  rent.  But 
such  a  situation  is  somewhat  artificial,  and  the  distinction 
between  land  and  other  property  is  from  this  point  of  view 
even  more  so. 

The  importance  of  property-ownership  in  connection 
with  profit  will  be  even  greater  and  more  apparent  if  "good- 
will," business  connection,  and  established  reputation,  etc., 
be  regarded  as  property.  If  these  categories  are  capitalized 
and  included  in  investment  the  cases  are  rare  indeed  where 
an  employer  of  others'  labor  and  capital  has  no  investment 
of  his  own  in  the  undertaking.  As  to  the  proper  procedure 
in  dealing  with  these  items,  whether  they  should  or  should 
not  be  regarded  as  property,  the  answer  depends  on  whether 
they  are  salable.  If  good-will  is  separable  from  the  other 
elements  in  a  business,  the  test  of  which  is  that  it  can  be 
sold  away  from  them  without  affecting  their  value,  then  it 
is  property  on  its  own  account,  and  the  competitive  rate  of 
return  on  its  sale  value  must  be  deducted  from  the  owner's 
income  before  a  pure  profit  is  arrived  at.  If  good-will  is 
inseparable  from  some  other  property  element,  such  as  a 
site,  it  is  a  factor  in  the  value  of  that  piece  of  property,  and 
income  on  the  total  value  must  similarly  be  considered  a 
property  income,  not  a  pure  profit.  If  the  good-will  inheres 
in  the  person  of  the  owner,  however,  it  is  not  property, 


308  RISK,  UNCERTAINTY,  AND  PROFIT 

but  an  element  in  the  personal  service  of  the  owner,  and 
its  proper  income  is  a  wage;  again  not  a  profit.  In  so  far  as 
its  value  (in  the  capital  or  revenue  sense)  can  be  appraised, 
it  must  be  considered  as  entitled  to  a  contractual  return 
and  does  not  give  rise  to  profit  in  the  narrow  sense. 

Our  discussion  of  the  meaning  of  profit  may  now  be 
summed  up  in  a  few  brief  statements.  Organization  in- 
volves the  concentration  of  responsibility,  placing  resources 
belonging  to  a  large  number  of  individuals  under  centralized 
control.  Examination  shows  that  the  human  functions  in 
production  involve  making  decisions,  exercising  control, 
/"but  that  this  control  is  not  final  unless  combined  with  as- 
I  sumption  of  the  results  of  the  decisions.  The  responsible 
decision  relates  to  men  rather  than  things;  the  ultimate 
manager  is  he  who  plans  the  organization,  lays  out  func- 
tions, selects  men  for  functions  and  appraises  their  value  to 
the  organization  as  a  whole,  in  competition  with  all  other 
bidders  in  the  market.  'For  this  ultimate  management 
there  is  but  one  possible  remuneration,  the  residuum  of 
product  remaining  after  payment  is  made  at  rates  es- 
tablished in  competition  with  all  comers  for  all  services  of 
men  or  things  for  which  competition  exists.1  This  residuum 
is  profit;  it  is  the  remainder  out  of  the  value  realized  from 
the  sale  of  product  after  deduction  of  the  values  of  all 
factors  in  production  which  can  be  valued,  or  after  all  the 
product  has  been  imputed  to  productive  elements  which 
can  be  imputed  by  the  competitive  mechanism.  Profit  is 
unimputable  income,  as  distinguished  from  the  total  in- 
come of  the  owner  of  the  business.  Normally  there  are 
other  elements  in  this  total  income,  which,  since  they  are 
not  paid  out  by  the  business,  may  be  said  not  to  be  im- 
puted, or  they  may  be  described  as  "residually  imputed." 
Pure  profit  is  theoretically  unimputable,  in  the  sense  in 
which  the  competitive  system  of  industrial  organization 

1  Including,  of  course,  monopoly  elements  in  the  situation.  Cf .  above, 
chapter  vi. 


ENTERPRISE  AND  PROFIT  309 

imputes  product  value  to  agencies  concerned  in  production. 
In  this  competitive  process,  all  the  product  value  which 
can  be  associated  with  any  agency  will  accrue  to  that 
agency.  The  essence  of  the  process  is  the  bidding  of  entre- 
preneurs or  would-be  entrepreneurs  for  the  use  of  produc- 
tive services  in  the  future,  the  rates  of  remuneration  being 
determined  by  a  present  general  competitive  estimate  of 
the  values  of  the  services  in  the  market,  while  the  return 
finally  received  from  their  use  may  diverge  from  this  esti- 
mate in  view  of  the  fact  of  uncertainty  or  liability  to  error 
in  all  human  prognostications.  As  far  and  as  fast  as  any 
portion  of  income  can  be  known  in  advance  to  be  connected 
with  the  exercise  of  superior  judgment,  it  will  be  imputed 
to  the  person  possessing  the  unusual  powers,  and  will  be- 
come a  wage  (of  management),  no  longer  a  profit.  Wages 
of  management  are  not  different  in  principle  from  wages 
for  routine  work;  management  is  routine  work  when  the 
term  is  properly  understood  in  the  present  connection. 
The  true  uncertainty  in  organized  life  is  the  uncertainty 
in  an  estimate  of  human  capacity,  which  is  always  a  capa- 
city to  meet  uncertainty. 

In  general  practice  the  ownership  of  property  is  neces- 
sary to  the  assumption  of  genuine  responsibility,  and  in  the 
typical  modern  business  organization  the  responsible  owner 
furnishes  no  labor  services  to  the  business,  but  property 
services  only.  In  such  a  case  profit  in  our  sense  of  the 
term  appears  as  a  difference  between  the  rate  of  return  on 
the  owner's  investment  and  a  competitive  rate  of  return 
on  investment  generally.  The  scientific  use  of  the  term 
"profit"  must  therefore  be  distinguished  from  the  various 
loose  uses  of  the  term  in  business,  and  particularly  from  the 
net  revenue  of  the  owner;  it  is  well  to  use  a  special  expres- 
sion, such  as  "pure  profit,"  to  distinguish  the  share  which 
is  accurately  residual,  theoretically  different  from  the 
returns  from  routine  functions,  imputed  by  competition 
to  the  agents  which  earn  them.   We  must  bear  in  mind, 


310  RISK,  UNCERTAINTY,  AND  PROFIT 

however,  that  the  imputed  or  competitive  element  in  the 
owner's  income  does  not  bear  quite  the  same  relation  to 
the  price  of  the  product  as  outlays  actually  incurred.  The 
expectation  of  such  a  return  at  the  general  competitive  rate 
is  a  condition  of  the  production  of  that  business 's  contribu- 
tion to  the  total  supply  of  a  commodity,  but  its  realization 
cannot  be  said  to  be  necessary. 

If  it  is  necessary  to  distinguish  between  profit  and  wages, 
it  is  just  as  vital  to  contrast  profit  with  payment  for  risk- 
taking  in  any  ordinary  use  of  the  terms.  An  insurer,  in  so 
far  as  his  business  is  reduced  to  a  science,  takes  no  risk;  the 
risk  in  the  individual  case  of  the  insured  is  obliterated  on 
being  thrown  in  with  the  multitude  of  cases  of  the  insurer. 
And  it  is  immaterial  whether  the  "cases"  are  a  homoge- 
neous group  of  similars  or  whether  each  is  objectively  in  a 
class  by  itself,  if  the  true  probability  can  be  ascertained. 
The  "risk"  which  gives  rise  to  profit  is  an  uncertainty  which 
cannot  be  evaluated,  connected  with  a  situation  such  that 
there  is  no  possibility  of  grouping  on  any  objective  basis 
whatever.  For  while  it  is  true  that  decisions  made  by  an 
individual  tend  to  approximate  an  objective  value  when 
considered  as  a  group,  decisions  of  this  character  reduce  to 
routine  and  do  not  involve  ultimate  responsibility;  in  so 
far  as  the  powers  of  the  entrepreneur  become  evaluated,  a 
definite  return  is  imputed  to  his  activity,  and  this  return 
is  no  longer  a  profit,  but  a  wage.1 
I    The  only  "risk"  which  leads  to  a  profit  is  a  unique  un- 

1  The  hiring  of  men  to  meet  uncertainty  can  be  illustrated  by  many 
examples  from  different  fields.  Corporations  employ  at  set,  fixed  wages 
inventors,  experimenters,  prospectors  for  minerals,  weather  and  crop 
forecasters,  market  predictors,  speculators,  etc.  Gambling-houses  pay 
men  weekly  salaries  to  play  poker  with  their  clients.  It  is  clear  that  such 
employees,  like  the  hired  manager,  make  decisions  as  a  matter  of  routine, 
without  taking  responsibility.  The  responsible  decision  is  made  by  the 
employer,  who  selects  them  for  their  tasks,  and  the  operation  of  the  prin- 
ciple of  consolidation  of  uncertainties  is  also  apparent.  The  latter  point 
is  not  so  clear  in  other  cases;  the  doctor  makes  decisions,  but  his  patients 
take  the  responsibility  for  their  correctness! 


ENTERPRISE  AND  PROFIT  311 

certainty  resulting  from  an  exercise  of  ultimate  responsi-  \ 
bility  which  in  its  very  nature  cannot  be  insured  nor  capi- 
talized nor  salaried.  Profit  arises  out  of  the  inherent,  abso- 
lute unpredictability  of  things,  out  of  the  sheer  brute  fact 
that  the  results  of  human  activity  cannot  be  anticipated 
and  then  only  in  so  far  as  even  a  probability  calculation  in 
regard  to  them  is  impossible  and  meaningless.  The  receipt 
of  profit  in  a  particular  case  may  be  argued  to  be  the  result 
of  superior  judgment.  But  it  is  judgment  of  judgment, 
especially  one's  own  judgment,  and  in  an  individual  case 
there  is  no  way  of  telling  good  judgment  from  good  luck, 
and  a  succession  of  cases  sufficient  to  evaluate  the  judg- 
ment or  determine  its  probable  value  transforms  the  profit 
into  a  wage. 

The  fundamental  fact  of  organized  activity  is  the  ten- 
dency to  transform  the  uncertainties  of  human  opinion  and 
action  into  measurable  probabilities  by  forming  an  approxi- 
mate evaluation  of  the  judgment  and  capacity  of  the  man. 
The  ability  to  judge  men  in  relation  to  the  problems  they 
are  to  deal  with,  and  the  power  to  "inspire"  them  to  effi- 
ciency in  judging  other  men  and  things,  are  the  essential 
characteristics  of  the  executive. 

If  these  capacities  are  known,  the  compensation  for 
exercising  them  can  be  competitively  imputed  and  is  a 
wage;  only,  in  so  far  as  they  are  unknown  or  known  only 
to  the  possessor  himself,  do  they  give  rise  to  a  profit. 
The  powers  and  attributes  of  leadership  form  the  most 
mysterious  as  well  as  the  most  vital  endowment  which  fits 
the  human  species  for  civilized  or  organized  life,  transcend- 
ing even  that  power  of  perceiving  and  associating  qualities 
and  relations  which  is  the  true  nature  of  what  we  call 
reasoning.  It  is  the  margin  of  error  in  this  most  ultimate 
faculty  of  judging  faculties*  whose  exercise  is  the  essence  of 
responsible  control,  which  constitutes  the  only  true  uncer- 
tainty in  the  workings  of  the  competitive  organization  (as 
of  any  other  organization).   And  it  is  uncertainty  in  this 


312  RISK,  UNCERTAINTY,  AND  PROFIT 

sense  which  explains  profit  in  the  proper  use  of  the  term, 
the  sense  toward  which  economic  usage  has  been  groping, 

tthat  of  a  pure  residual  income,  unimputable  by  the  mechan- 
ism of  competition  to  any  agent  concerned  in  its  creation. 
It  remains  to  follow  out  this  line  of  reasoning  in  detail, 
to  show  how  a  large  part  of  the  phenomena  of  current  eco- 
nomic life,  on  the  organization  side,  are  the  natural  results 
of  the  fact  of  uncertainty  and  this  fundamental  method  of 
meeting  it.  But  it  seems  best  to  postpone  this  further  dis- 
cussion until  we  have  examined  the  bearings  of  progressive 
change  on  the  amount  and  kind  of  uncertainty  involved  in 
economic  life.  These  two  chapters  have  dealt  only  with 
the  more  fundamental  features  of  free  enterprise  which 
would  be  met  with  even  in  a  society  as  nearly  static  as 
material  possibility  admits,  and  in  which  a  minimum  degree 
of  uncertainty  would  be  present.  We  have  abstracted  from 
many  important  features  of  entrepreneurship  which  are 
connected  with  the  fact  of  progress  or  the  presence  of  the 
conditions  of  progress,  for  progress  involves  uncertainty  in 
a  high  degree  and  in  very  special  forms.  We  turn  now  to 
consider  the  bearings  upon  economic  organization  of  the 
various  dynamic  factors  or  elements  of  progress  *  and  the 
uncertainty  connected  with  them. 

1  See  chapter  v. 


CHAPTER  XI 

UNCERTAINTY  AND  SOCIAL  PROGRESS 

The  general  character  of  the  connection  between  progress 
and  uncertainty  has  been  dealt  with  at  various  points  in 
the  course  of  our  inquiry.  Change  of  some  kind  is  prerequi- 
site to  the  existence  of  uncertainty;  in  an  absolutely  un- 
changing world  the  future  would  be  accurately  foreknown, 
since  it  would  be  exactly  like  the  past.  Change  in  some 
sense  is  a  condition  of  the  existence  of  any  problem  what- 
ever in  connection  with  life  or  conduct,  and  is  the  actual 
condition  of  most  of  the  problems  of  pure  thought,  since 
these  are  after  all  more  or  less  related  to  practical  require- 
ments. We  live  in  a  world  full  of  contradiction  and  para- 
dox, a  fact  of  which  perhaps  the  most  fundamental  illus- 
tration is  this :  that  the  existence  of  a  problem  of  knowledge 
depends  on  the  future  being  different  from  the  past,  while 
the  possibility  of  the  solution  of  the  problem  depends  on 
the  future  being  like  the  past.  The  key  to  the  paradox,  as 
we  have  argued  above  (chapter  vii),  is  to  be  found  in  two 
facts.  In  the  first  place,  we  analyze  our  world  into  objects 
which  behave  more  or  less  consistently.  That  is,  we  recog- 
nize in  things  the  unchanging  property  of  changing  in  cer- 
tain ways.  If  this  process  could  be  carried  out  to  complete- 
ness, we  should  have  a  completely  knowable  world.  It 
would  also,  however,  be  in  the  practical  sense  an  un- 
changing world.  It  is  a  fact  familiar  to  students  of  our 
thought  processes  that  we  thus  explain  change  by  explain- 
ing it  away.  The  historic  problem  of  thought  is  this  of 
real  change.  The  point  for  us  here  is  that  change  according 
to  known  law  (whether  or  not  we  call  it  change)  does  not 
give  rise  to  uncertainty.  What  we  practically  mean  by  a 
static  world  is  one  in  which  all  change  is  of  this  character. 
But  the  process  of  formulating  change  in  terms  of  un- 


314  RISK,  UNCERTAINTY,  AND  PROFIT 

changing  "laws"  (properties  or  modes  of  behavior  of 
"things")  cannot  be  carried  to  completeness,  and  here  our 
minds  invent  a  second  refuge  to  which  to  flee  from  an  un- 
knowable world,  in  the  form  of  the  law  of  permutations 
and  combinations.  A  law  of  change  means  given  behavior 
under  given  conditions.  But  the  "given  conditions"  of  the 
behavior  of  any  object  are  the  momentary  states  and 
changes  of  other  objects.  Hence  the  dogma  of  science,  that 
the  world  is  "really"  made  up  of  units  which  not  only  do 
not  change  (atoms,  corpuscles,  ether,  or  what-not),  but 
whose  laws  of  behavior  are  simple  and  comprehensible. 
But  it  is  contended  that  there  are  so  many  of  these  units 
that  the  simple  changes  which  they  undergo  (ideally  move- 
ments in  space  alone)  give  rise  to  a  variety  of  combinations 
which  our  minds  are  unable  to  grasp  in  detail.  We  have 
examined  this  dogma  and  been  forced  to  the  conclusion 
that  whatever  we  find  it  pleasant  to  assume  for  philosophic 
purposes,  the  logic  of  our  conduct  assumes  real  indetermin- 
ateness,  real  change,  discontinuity. 

Even  the  assumption  of  real  indeterminateness,  however, 
gives  mind  a  new  means  of  prediction,  through  grouping 
phenomena  into  classes  and  applying  probability  reasoning. 
This  device  enables  us  to  predict  what  will  happen  in 
groups  of  instances  where  we  find  it  impossible  to  derive 
laws  fitting  individual  cases.  The  second  fundamental  fact 
of  uncertainty  is  that  this  method  also  has  its  limits.  Both 
methods  in  fact,  prediction  by  law  in  individual  cases  and 
by  probability  reasoning  in  groups  of  cases,  have  rather 
narrow  limitations  in  everyday  life  in  consequence  of  the 
organic  costs  of  applying  them  and  the  time  required  to 
get  the  necessary  data;  both  outlay  and  time  are  com- 
monly much  greater  than  circumstances  will  allow  us  to 
consume  in  deciding  upon  a  course  of  action.  The  actual 
procedure  of  making  decisions  in  practical  life  is  a  rather 
inscrutable  or  "intuitive"  formation  of  "estimates,"  sub- 
ject to  a  wide  margin  of  error  or  uncertainty. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       315 

The  significance  of  change  is  that  it  gives  rise  to  the  prob- 
lem of  the  control  of  action,  and  in  this  respect  the  dif- 
ference between  predictable  and  unpredictable  change  is 
conspicuous.  The  succession  of  day  and  night  or  the  alter- 
nation of  the  seasons,  the  vital  processes  and  changes  of  our 
own  lives,  waking  and  sleeping,  work-time  and  meal-time 
and  play-time,  infancy,  maturity,  and  age  —  such  events 
call  for  action,  but  give  rise  to  no  problem  of  action;  they 
are  predictable.  Problems  of  action  arise  out  of  departures 
from  routine  in  changes  of  all  sorts.  It  is  a  common  obser- 
vation that  irregularities  would  be  of  much  less  magnitude 
and  consequence  in  the  absence  of  social  progress,  and 
a  common  practice  to  distinguish  between  "static"  and 
"dynamic"  risks.  The  fundamental  difference,  as  we  have 
seen,  is  one  of  degree  only,  and  consists  in  the  greater  un- 
predictability of  some  actual  progressive  changes.  In  the 
first  place,  it  is  impossible  to  draw  a  sharp  and  significant 
distinction  between  progressive  change  and  fluctuations. 
Everything  depends  on  the  periodicity  of  the  change.  If  it 
is  self -compensating  in  an  interval  short  as  compared  with 
the  length  of  human  life,  it  does  not  involve  uncertainty, 
and  the  increasing  perfection  of  organization  devices  de- 
signed to  secure  consolidation  constantly  extends  the  period 
over  which  effective  self-compensation  may  come  about. 
On  the  other  hand,  all  our  progressive  changes  may  be 
ultimately  periodic  for  all  we  know. 

Again,  progressive  change  does  not  necessarily  carry  un- 
predictability with  it;  indeed,  a  merely  progressive  change 
does  not.  If  the  change  takes  place  uniformly,  or  in  ac- 
cordance with  any  known  mathematical  function  of  time, 
the  future  may  be  foreknown  as  accurately  as  if  there  were 
no  change.  It  is  fluctuation  after  all  which  is  the  true 
cause  of  the  uncertainty,  fluctuation  in  progress.  In  fact 
some  changes  are  fairly  "constant"  in  their  operation  and 
do  not  give  rise  to  uncertainties  of  the  sort  which  disturb 
the  operation  of  competition.  Of  this  sort  are  the  increase 


316  RISK,  UNCERTAINTY,  AND  PROFIT 

of  population  and  the  accumulation  of  capital.  Others  are 
highly  capricious  in  their  action  and  continually  upset  the 
calculations  upon  the  basis  of  which  entrepreneurs'  bids 
for  productive  service  are  made. 

Scrutiny  of  the  character  of  the  progressive  changes 
which  we  have  recognized  (chapter  v)  as  significant  in  the 
study  of  economics  reveals  some  interesting  similarities  and 
differences  among  them.  If  we  begin  by  distinguishing  be- 
tween natural  changes  and  changes  due  to  human  action, 
we  note  that  we  do  not  have  to  consider  any  progressive 
changes  under  the  former  head.  Natural  changes  are 
either  of  the  nature  of  fluctuations  from  a  constant  con- 
dition or  else,  like  the  supposed  cooling-off  of  the  solar 
system,  so  slow  as  to  make  no  difference  for  human  cal- 
culations. The  changes  due  to  acts  of  man  are,  however,  of 
two  different  kinds.  Some  are  produced  by  deliberate  in- 
tent and  others  come  about  more  or  less  incidentally  as  a 
result  of  actions  directed  toward  other  ends.  A  study  of 
the  "real"  motives  of  action  would  lead  far  afield,  and 
probably  yield  no  very  clear  and  satisfactory  results  at 
last,  but  we  can  make  a  rough  distinction.  The  improve- 
ment of  technology  and  in  large  part  the  discovery  of 
natural  resources  are  directly  willed,  though  the  latter  is  to 
a  more  considerable  extent  accidental.  The  accumulation 
of  capital  may  be  treated  as  deliberately  effected,  though 
with  some  reservations,  and  the  various  redistributions  of 
things  among  persons  may  be  similarly  treated,  but  with 
more  reservations.  The  improvement  of  wants  is  partly  a 
deliberate  matter,  partly  incidental  to  other  endeavors, 
and  partly  it  "just  happens."  The  increase  in  population 
is  hardly  willed  at  all;  the  matter  of  its  innate  quality  is 
even  less  affected  by  volitional  interference  (and  in  fact 
unquestionably  shows  rapid  retrogression  under  modern 
industrial  conditions);  while  the  education  and  training 
of  the  individual  are  controlled  by  a  baffling  mixture  of 
planned  action  and  accident. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       317 

Another  dichotomy  of  fundamental  importance  for  the 
study  of  uncertainty  relates  to  the  production  as  con- 
trasted with  the  consumption  of  wealth.  This  distinction 
is  also  well  recognized  in  discussions  of  uncertainty,  the 
technological  "risks"  being  separated  from  those  con- 
nected with  market  changes.  It  is  interesting  to  observe 
in  the  evolution  of  the  modern  industrial  organization  how 
the  marketing  function  has  consistently  dominated  that  of 
production  proper.  We  have  already  pointed  out  that  the 
most  fundamental  determining  fact  in  connection  with  or- 
ganization is  the  meeting  of  uncertainty.  The  responsible 
decisions  in  organized  economic  life  are  price  decisions; 
others  can  be  reduced  to  routine  and  men  can  be  hired  to 
make  them.  The  uncertainties  of  the  market  resist  elimina- 
tion or  reduction  by  grouping  more  doggedly  than  do  those 
connected  with  technological  processes.  Even  in  the  transi- 
tion period  between  the  mediaeval  and  modern  eras  it  was 
the  marketing  guilds  which  gravitated  into  positions  of 
control,  became  the  "Liveried  Companies"  and  employed 
the  producers  and  set  them  at  their  tasks,  owning  the 
materials  they  worked  upon  and  the  product  when  com- 
pleted. 

It  will  be  observed  that  the  main  uncertainty  which 
affects  the  entrepreneur  is  that  connected  with  the  sale 
price  of  his  product.  His  position  in  the  price  system  is 
typically  1  that  of  a  purchaser  of  productive  services  at 
present  prices  to  convert  into  finished  goods  for  sale  at  the 
prices  prevailing  when  the  operation  is  finished.  There  is  no 
uncertainty  as  to  the  prices  of  the  things  he  buys.  He 
bears  the  technological  uncertainty  as  to  the  amount  of 
physical  product  he  will  secure,  but  the  probable  error  in 
calculations  of  this  sort  is  generally  not  large;  the  gamble  is 
in  the  price  factor  in  relation  to  the  product.  But  changes 

1  In  many  instances,  of  course,  this  situation  is  inverted;  the  selling 
price  is  known  in  advance  by  contracting  and  it  is  the  cost  outlays  which 
are  uncertain. 


I 


318  RISK,  UNCERTAINTY,  AND  PROFIT 

in  the  prices  of  producers*  goods  affect  him  indirectly,  be- 
cause they  are  likely  to  be  connected  with  changes  in  prod- 
uct prices;  they  form  one  of  the  factors  to  be  taken  into 
account  in  forecasting  the  sales  market.  This  is  probably  a 
secondary  consideration,  however,  except  in  so  far  as  capi- 
tal values  are  involved,  a  fundamental  exception,  to  be 
sure,  which  will  have  to  be  discussed  at  length  presently. 
The  main  immediate  sources  of  uncertainty  are  the  amount 
of  supply  to  be  expected  from  other  producers  and  the 
consumers'  wants  and  purchasing  power. 

The  most  fundamentally  and  irretrievably  uncertain 
phases  or  factors  of  progress  are  those  which  amount  es- 
sentially to  the  increase  of  knowledge  as  such.  This  de- 
scription evidently  holds  for  the  improvement  of  technologi- 
cal processes  and  the  forms  of  business  organization  and  for 
the  discovery  of  new  natural  resources.  Here  it  is  a  contra- 
diction in  terms  to  speak  of  anticipation,  in  an  accurate  and 
detailed  sense,  for  to  anticipate  the  advance  would  be  to 
make  it  at  once.  Yet  even  here,  as  we  have  seen,  change 
and  the  uncertainty  of  change  are  in  some  degree  separable 
factors.  Though  we  cannot  describe  a  new  invention  in 
advance  without  making  it,  nor  say  what  quantity  and 
quality  of  new  natural  productive  capacity  will  be  devel- 
oped and  where,  yet  it  is  possible  in  a  large  degree  to  offset 
ignorance  with  knowledge  and  behave  intelligently  with 
regard  to  the  future.  These  changes  are  in  large  part  the 
result  of  deliberate  application  of  resources  to  bring  them 
about,  and  in  the  large  if  not  in  a  particular  instance,  the 
results  of  such  activity  can  be  so  far  foreseen  that  it  is 
even  possible  to  hire  men  and  borrow  capital  at  fixed  re- 
munerations for  the  purpose  of  carrying  it  on. 

Two  further  general  observations  are  called  for  before  we 
can  take  up  in  detail  the  effects  of  the  uncertainties  in- 
volved in  progress  upon  the  form  and  workings  of  the  com- 
petitive economic  organization.  It  is  common  to  think  of 
the  economic  process  as  the  production  of  goods  for  the 


UNCERTAINTY  AND  SOCIAL  PROGRESS       319 

satisfaction  of  wants.  This  view  is  deficient  in  two  vital 
respects.  In  the  first  place,  the  economic  process  produces 
wants  as  well  as  goods  to  satisfy  existing  wants,  and  the 
amount  of  social  energy  devoted  to  the  former  and  neg- 
lected phase  of  activity  is  very  large  and  constantly  grow- 
ing. The  second  point  is  that  the  production  of  the  in- 
direct means  of  want-satisfaction  is  by  no  means  altogether 
directed  to  the  ultimate  satisfaction  of  wants  in  any  direct 
sense  of  the  terms.  The  increase  in  wealth  is  to  a  large 
extent  an  end  in  itself  as  well  as  a  means  to  the  increase  of 
income,  and  this  also  again  to  a  rapidly  increasing  degree  as 
the  standards  of  life  are  advanced.  Men  work  "to  get  rich  " 
in  a  large  proportion  of  cases,  not  merely  in  addition  to, 
but  in  place  of,  consuming  larger  amounts  of  goods.  It  is  a 
grave  error  to  assume  that  in  a  modern  industrial  nation 
production  takes  place  only  in  order  to  consumption.  It  is 
true  to  a  great  and  ever-increasing  degree  that  consump- 
tion is  sacrificed  to  increased  production.  Whatever  our 
philosophy  of  human  motives,  we  must  face  the  fact  that 
men  do  "raise  more  corn  to  feed  more  hogs,  to  buy  more 
land  to  raise  more  corn  to  feed  more  hogs  to  buy  more  land," 
and,  in  business  generally,  produce  wealth  to  be  used  in  pro- 
ducing more  wealth  with  no  view  to  any  use  beyond  the 
increase  of  wealth  itself. 

From  the  standpoint  of  effects  upon  organization  we 
must  distinguish  between  the  various  phases  of  progress 
already  enumerated  (in  chapter  v),  the  increase  of  popula- 
tion, education  and  training,  accumulation  of  capital,  im- 
provement in  technology  and  business  organization,  dis- 
covery of  new  natural  resources,  and  changes  in  the  char- 
acter of  human  wants.  The  most  important  of  these  from 
our  point  of  view  and  at  the  same  time  the  one  easiest  to 
discuss  intelligently  is  the  accumulation  of  capital. 

Let  us  begin  with  the  relation  of  capital  in  the  sense  of 
material  goods  to  the  fundamental  structure  of  society. 
The  facts  of  progress  will  be  seen  to  have  an  intimate  con- 


320  RISK,  UNCERTAINTY,  AND  PROFIT 

nection  with  the  very  institution  of  private  property.  In 
an  unprogressive  society  private  property  in  the  modern 
sense  of  the  term  need  not  exist.  The  social  justification  of 
private  ownership  is  that  the  coupling  of  control  of  re- 
sources with  enjoyment  of  the  fruits  of  their  use  is  sup- 
posed to  give  an  incentive  to  use  the  goods  effectively  in 
production.  The  abolition  of  slavery  or  property  in  hu- 
man beings  rests  on  the  fact  that  slaves  do  not  work  as  ef- 
fectively as  free  men,  and  it  turns  out  to  be  cheaper  to 
pay  men  for  their  services  and  leave  their  private  lives  un- 
der  their  own  control  than  it  is  to  maintain  them  and  force 
them  to  labor. 

The  same  reasoning  applies  to  property  in  material 
things,  but  in  an  unprogressive  state  the  force  of  the  argu- 
ment is  relatively  weak.  When  production  methods  are  a 
matter  of  routine,  as  in  the  Middle  Ages,  and  there  is  no 
thought  of  progress,  common  ownership  of  land  and  tools 
is  the  rule.  The  problem  of  control  becomes  acute  when 
methods  are  changing,  and  the  incentive  to  change  methods 
is  mainly  the  desire  to  increase  property  values,  to  "get 
rich."  We  can  hardly  over-emphasize  the  fact  that  the 
dynamic  urge  back  of  modern  economic  life  is  the  desire  to 
increase  wealth,  rather  than  a  desire  to  consume  goods, 
though  there  is  a  psychological  connection  of  an  irrational 
sort  between  the  two  considerations.  Even  when  im- 
provement in  standards  of  living  does  result  from  the  in- 
crease of  wealth,  it  cannot  be  assumed  that  this  was  the 
motive;  for  as  we  have  previously  emphasized,  a  permanent 
net  increase  of  wealth  must  come  from  a  surplus  produc- 
tion on  the  part  of  individuals  which  they  never  plan  to 
consume,  but  expect  to  die  and  leave  behind  them.1 

1  A  small  amount  of  capital  wealth  would,  of  course,  result  from  the 
temporary  investment  of  savings  later  withdrawn  and  consumed.  An 
adequate  discussion  of  the  motives  involved  in  the  production  of  such 
surplus  wealth  would  be  beyond  the  scope  of  this  work.  The  writer  would 
say,  however,  that  the  theory  of  an  "instinct"  of  acquisition  or  accumula- 
tion seems  to  him  to  be  even  below  the  plane  of  scientific  thinking  of  the 


UNCERTAINTY  AND  SOCIAL  PROGRESS       321 

The  most  direct  connection  of  the  uncertainties  of  prog- 
ress with  economic  theory  in  the  conventional  use  of  the 
term  is  in  relation  to  the  explanation  of  interest.  Interest 
is  a  phenomenon  connected  with  the  increase  of  the  ma- 
terial equipment  of  society  and  dependent  on  the  uncer- 
tainty involved  in  the  process.  It  might  or  might  not  exist 
in  a  "static"  society,  depending  largely  on  how  rigidly  the 
term  "static"  is  interpreted.  If  productive  goods  were  not 
changeable  in  either  form  or  amount  or  distribution  there 
would  be  no  occasion  for  the  lending  of  free  capital,  and 
interest  would  not  exist;  if  all  equipment  were  fixed  in  form 
and  amount,  but  transferable  from  one  individual  to  an- 
other, it  might  exist;  with  productive  goods  fixed  in  amount 
(no  net  saving  or  consumption  of  "capital"  taking  place), 
but  changeable  in  form,  interest  would  doubtless  be  found, 
but  would  make  no  appreciable  difference  in  the  distribu- 
tion of  income,  as  it  would  differ  in  very  little  but  name 
from  rent.1 

To  understand  interest  it  is  necessary  to  have  clearly  in 
view  the  mechanism  of  the  creation  of  capital  equipment 
through  the  process  of  saving  and  investment.  The  clas- 
sical conception  of  capital  as  "advances  to  laborers"  2  is 

famous  "dormitive  virtue"  of  opiates.  The  latter  at  least  is  a  real  prop- 
erty or  mode  of  behavior  of  something,  while  the  human  activity  of  ac- 
cumulation is  not  a  distinctive  reaction,  but  a  manifestation  of  the  same 
tendencies  found  in  human  conduct  generally.  The  "creative"  or  "con- 
structive" impulse  is  open  to  the  same  objection;  the  "pleasure  of  being  a 
cause"  used  by  Gross,  Preyer,  Cooley,  and  others  seems  to  be  the  best 
description  of  action  not  directed  to  gratifying  an  immediate  and  con- 
scious need  of  the  organism  as  a  vital  machine.  It  is  merely  a  confusing 
misuse  of  terms  to  call  an  undifferentiated  and  undirected  tendency  to 
action-in-general  an  "instinct." 

1  See  above,  chapter  v,  where  it  is  shown  that  the  "capitalization  rate" 
which  would  determine  or  rather  arise  out  of  the  sale- value  of  property  on 
the  second  of  the  above  assumptions  is  not  interest  in  the  proper  sense  of 
the  term,  and  that  its  rate  is  determined  by  "psychological"  considera- 
tions of  "time-preference,"  very  different  from  the  forces  which  deter- 
mine the  rate  of  interest  in  the  present  world.  These  forces  we  now  pro- 
ceed to  analyze  more  in  detail. 

2  Substantially  followed  by  Taussig,  and  rightly  so.  See  Wages  and 
Capital;  also  Principles  of  Economics,  chaps.  38-40. 


322  RISK,  UNCERTAINTY,  AND  PROFIT 

essentially  sound  at  least  as  a  starting-point,  though  it 
must  be  amended  or  qualified  in  two  particulars.  The  de- 
scription applies,  first,  only  to  new  or  "free"  capital,  capi- 
tal in  the  process  of  formation;  it  is  true  in  the  sense  that 
capital  goods  come  into  existence  through  an  "advance- 
ment" of  consumption  goods.  In  the  second  place,  the 
advances  are  not  made  to  laborers  only,  but  to  owners  of 
already  existing  capital  goods  (and  natural  resources  if 
these  are  separated  from  capital  goods)  as  well.  The  diffi- 
culties and  confusions  with  which  interest  theory  is  beset 
arise  largely  from  the  use  of  terms,  notably  the  ambiguity 
of  the  term  "capital."  In  the  discussion  which  follows  we 
shall  employ  the  expression  "capital  goods"  to  refer  to 
"the  produce  of  past  industry  used  for  further  production," 
the  concrete  instruments  and  tools,  and  restrict  the  term 
"capital"  to  a  much  narrower  meaning,  relating  to  this 
antecedent  stage  in  the  creation  of  capital  goods  or  to  their 
value  as  distinct  from  the  goods  themselves. 

The  nature  of  capital  creation  has  been  made  clear  by 
many  writers.  The  primitive  man  constructs  his  own 
equipment  to  increase  the  efficiency  of  his  own  labor,  and 
what  he  dies  possessed  of  is  likely  to  be  buried  with  him. 
In  organized  civilized  life  the  process  is  different  in  two 
respects.  In  consequence  of  specialization  certain  persons 
devote  their  energies  altogether  to  the  production  of  equip- 
ment goods,  others  not  at  all;  and  in  the  second  place,  a 
great  permanent  fund  of  goods  is  built  up  and  maintained 
and  increased  from  generation  to  generation.  Yet  what 
happens  on  the  whole  is  fundamentally  the  same,  though 
the  division  of  labor  makes  it  somewhat  more  difficult  to 
see.  Those  who  are  engaged  in  the  making  of  equipment 
goods  are  naturally  not  at  the  same  time  making  their 
own  living;  they  must  five  out  of  a  surplus  of  consumption 
goods  either  stored  up  in  advance  or  diverted  from  the  use 
of  those  who  produce  it  contemporaneously.  In  either  case 
the  first  requisite  to  capital  creation  is  the  creation  of  a 


UNCERTAINTY  AND  SOCIAL  PROGRESS       323 

surplus,  the  production  of  more  goods  than  are  consumed, 
by  somebody  at  some  time  prior  to  the  coming  into  exist- 
ence of  the  capital  goods.  This  is  the  essential  meaning  of 
"saving." 

In  civilized  society  the  makers  of  capital  goods  in- 
clude landlords  and  owners  of  capital  goods  as  well  as 
laborers.  All  who  furnish  productive  services  of  any  kind 
to  the  capital  goods  producing  operations  are  manifestly 
paid  out  of  prior  production  or  excess  contemporary  crea- 
tion of  consumption  goods  by  other  persons  and  equip- 
ment. The  essence  of  the  process  is  that  a  surplus  of  con- 
sumption goods,  set  aside  by  being  "saved,"  makes  pos- 
sible the  diversion  of  productive  resources  from  the  creation 
of  consumption  goods  to  the  creation  of  producers'  goods. 
This  is  what  is  meant  by  "advances." 

The  series  of  events  is  further  complicated  by  the  in- 
tervention of  money,  for  a  relatively  small  proportion  of 
students  of  economics  ever  learn  to  think  back  of  the  ex- 
change function  of  money  to  the  transfers  of  real  things 
mediated  by  it.  Saving  is  erroneously  thought  of  as  the 
saving  of  money,  and  the  income  of  the  producers  of  capi- 
tal goods  as  a  money  income.  Of  course  the  money  is  a 
mere  medium  of  exchange.  It  represents  to  the  saver  the 
ownership  of  a  certain  amount  of  the  wealth  of  society, 
which  can  be  "drawn"  or  "cashed"  in  any  form  he  pleases 
at  existing  prices.  If  the  saving  is  "invested,"  used  for 
capital  creation,  this  wealth  is  transferred  to  those  engaged 
in  these  operations  and  "cashed"  by  them  in  the  form  of 
the  things  they  want,  mainly  consumption  goods.  The 
title  to  these  things  is  what  the  saving  is  and  what  is  trans- 
ferred. The  transferred  goods  maintain  or  support  the  pro- 
ducers of  capital  goods,  including  laborers,  landowners,  and 
owners  of  capital  goods  who  would  otherwise  be  engaged 
in  making  consumption  goods  for  themselves  or  for  ex- 
change. Interest  arises  when  saved  wealth  is  not  invested 
by  the  saver,  but  transferred  by  loan  to  another  person, 


3U  RISK,  UNCERTAINTY,  AND  PROFIT 

either  direct  from  saver  to  investor  or  mediated  by  a  bank 
or  financial  institution  as  middleman. 

The  loan  at  interest  is  thus  a  means  of  securing  specializa- 
tion of  function,  enabling  one  set  of  persons  to  save  surplus 
wealth  and  another  set  to  convert  savings  into  capital 
goods  by  advancing  them  to  the  owners  of  productive  serv- 
ices who  then  use  these  services  to  create  the  capital 
goods  instead  of  the  consumption  goods  which  they  would 
have  been  used  to  produce  had  no  saving  taken  place.  The 
operations  could  be  carried  on  without  specialization;  di- 
vision of  labor  here  as  elsewhere  involves  economy  merely, 
but  is  not  the  only  way  of  getting  things  done.  The  savers 
could  advance  their  own  surpluses  to  owners  of  productive 
services  and  create  capital  goods  on  their  own  account, 
either  themselves  exploiting  these  new  productive  goods  or 
transferring  them  by  lease  to  other  entrepreneurs.  The 
gains  from  having  them  transfer  this  function  to  others 
who  make  investment  their  business  are  of  the  same 
character  as  the  gains  from  specialization  in  any  other 
connection. 

Notably  the  gains  are  the  same  as  those  which  arise 
from  the  specialization  of  the  entrepreneur  or  control-plus- 
responsibility  function,  for  this  is  what  is  really  involved  in 
the  loan.  Let  us  suppose  that  the  saver  does  his  own  ad- 
vancing and  comes  out  the  owner  of  the  capital  equipment 
which  results  from  his  saving;  what  will  he  do  with  it  then? 
He  might  also  employ  this  new  equipment  himself  in  the 
production  of  the  sort  of  goods  to  which  it  is  adapted, 
continuing  meanwhile  the  original  business  or  profession 
out  of  which  he  made  the  first  saved  surplus.  But  we 
know  that  it  is  in  general  much  better  and  much  more 
likely  to  happen  that  he  shall  lease  the  equipment  at  a 
fixed  rate  to  an  entrepreneur  for  actual  operation.  Let  us 
make  it  as  clear  as  possible  that  exactly  the  same  sort  of 
gains  are  realized  by  his  transferring  the  surplus  of  goods 
itself  to  an  entrepreneur  at  a  fixed  remuneration  and  leav- 


UNCERTAINTY  AND  SOCIAL  PROGRESS       325 

ing  to  the  latter  the  construction  as  well  as  operation  of 
the  new  equipment  (or  leaving  the  construction  and  opera- 
tion to  two  different  outside  entrepreneurs). 

The  saving  of  surpluses  is  clearly  one  function  or  opera- 
tion and  their  use  to  make  possible  the  creation  of  new 
equipment  another  and  quite  different  one,  just  as  the 
furnishing  of  productive  services  is  one  function  and  their 
use  in  the  production  of  goods  is  another.  In  fact  a  little 
reflection  will  show  that  the  operation  of  converting  sur- 
plus goods  into  capital  goods  partakes  in  an  especial  degree 
of  the  characteristics  which  lead  to  the  specialization  of 
the  entrepreneur  function  in  the  field  of  ordinary  productive 
operations :  namely,  it  involves  special  knowledge  and  fore- 
sight of  future  conditions.  A  surplus  of  consumption  goods 
is  fluid  capital;  it  may  be  used  to  create  any  hind  of  con- 
crete productive  instruments  whatever,  within  the  limits 
of  physical  possibility  and  arbitrary  social  control.  In  a 
society  which  permitted  such  use  it  could  be  made  to  pro- 
duce or  increase  a  supply  of  slave  labor.  It  can  as  a  matter 
of  fact  be  used  to  increase  the  supply  of  natural  agents  or 
to  invent  and  discover  new  ways  of  doing  things,  even  to 
create  new  wants  for  goods,  and  many  things  not  conven- 
tionally considered  capital  creation. 

The  burning  question  in  practice  is,  what  form  of  new  ' 
capital  goods  shall  be  created,  where,  by  what  methods, 
etc.  The  answer  is  an  exercise  of  judgment  of  far  the  highest 
type  called  for  in  the  business  world.  It  is  obviously  in- 
evitable that  the  function  of  answering  this  type  of  ques- 
tion will  be  specialized  along  the  same  lines  and  for  the 
same  reasons  as  the  control  of  enterprise  under  static  con- 
ditions. The  individuals  who  control  the  conversion  of 
saved  surpluses  into  capital  goods  must  take  the  responsi- 
bility for  their  decisions,  though  as  in  the  former  case  the 
"control"  may  take  the  form  of  selecting  some  one  else  to 
exercise  the  immediate  control  as  a  routine  task  performed 
without  responsibility  for  the  results.    The  call  for  the 


326  RISK,  UNCERTAINTY,  AND  PROFIT 

exercise  of  judgment  is  greater  as  the  uncertainties  of  prog- 
ress are  greater  than  those  of  routine  operations,  and  the 
necessity  that  the  responsibility  be  taken  by  the  person 
who  exercises  the  judgment  —  of  the  situation  or  of  the 
human  capacity  to  judge  it  —  is  correspondingly  great. 

Under  freedom  of  contract  the  machinery  which  natur- 
ally grows  up  for  effecting  this  specialization  is  the  machin- 
ery of  the  market,  working  in  the  same  way  as  in  the  case 
of  entrepreneurs'  bargains  with  the  owners  of  productive 
services.  Surplus  consumption  goods,  or  titles  to  these  in 
the  form  of  money  or  bank  deposits,  form  a  perfectly  stand- 
ardized commodity  of  an  ideal  sort  for  trading.  It  is  also 
extremely  mobile,  still  further  adapting  it  to  the  operations 
of  a  market  of  the  widest  scope.  Banks  and  financial  in- 
stitutions have  this  market  highly  organized.  The  actual 
workings  of  the  market  are  the  same  as  those  of  any  other 
market.  At  any  time  there  is  a  price  established,  which 
in  this  case  is  unusually  definite  and  uniform.  It  is  not, 
indeed,  a  single  homogeneous  commodity  that  is  dealt  in, 
for  funds  for  different  sorts  of  investment  admit  of  the 
specialization  of  the  entrepreneur  function  in  widely  differ- 
ent degrees.  But  after  all  the  loan  market  represents  a 
narrower  range  of  prices  according  to  grade  and  kind  of  the 
goods  than  is  true  of  nearly  any  other  market  to  be  named. 
Men  who  are  willing  to  purchase  at  the  established  price 
meet  men  who  are  willing  to  sell  at  that  price;  others  do  not 
enter  the  market.  If  more  of  the  commodity  is  offered 
than  will  be  taken  at  the  existing  price  the  price  falls,  and 
vice  versa,  keeping  the  price  constantly  adjusted  to  the  point 
which  equates  the  supply  and  demand. 

The  buyers'  decisions  to  enter  the  market  represent  a 
judgment  of  an  investment  opportunity  that  will  yield  a 
profit  (together  with  ability  to  give  the  security  demanded 
in  consideration  of  the  rate  on  the  particular  kind  of  loan). 
The  entrepreneur  in  this  case  must  make  an  estimate  of 
the  future,  involving  a  very  complicated  series  of  factors. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       327 

The  borrower  of  funds  (like  the  hirer  of  other  agencies)  for 
routine  productive  operations  estimates  the  physical  prod- 
uct to  be  turned  out  by  their  use  and  the  sale  price  of  this 
product.  The  borrower  for  the  purpose  of  creating  new 
capital  equipment  1  must  estimate  in  physical  terms  the 
results  of  his  constructive  operations,  the  physical  output 
of  his  equipment  after  it  is  in  use,  and  both  the  cost  and  the 
salability  of  that  product,  all  of  which  are  in  the  future  by 
the  interval  required  to  construct  the  equipment  in  addi- 
tion to  the  period  of  production  in  the  industry.  Besides 
all  which  it  must  be  kept  in  mind  that  the  construction  of 
a  new  productive  plant  includes  getting  it  into  operation, 
building  up  business  connections  in  the  markets  for  all  the 
things  the  business  must  purchase  as  well  as  the  things 
which  it  sells;  and  this  normally  requires  a  much  longer 
time  than  the  mere  mechanical  construction  of  the  plant. 
The  specialization  of  entrepreneur  activities  may  go  far- 
ther than  above  indicated  in  various  ways.  In  particular, 
the  use  of  surplus  goods,  represented  by  money  funds,  in 
constructing  new  production  goods  may  be  separated  from 
the  operation  of  the  new  equipment  when  constructed.  But 
for  obvious  reasons  this  is  also  likely  not  to  be  the  case. 
Construction  includes,  as  we  have  seen,  an  initial  period  of 
operation  longer  than  the  construction  period  itself  in  the 
narrow  sense,  and  the  overlapping  in  time  makes  them 
difficult  to  separate.  It  commonly  happens,  indeed,  that ' 
the  mechanical  part  of  building  a  plant  is  turned  over  for  a 
fixed  consideration  to  another  entrepreneur,  a  contractor. 
Of  course  the  starting  of  new  enterprises  with  a  view  to 
their  sale  or  even  lease  to  others  for  operation  after  they 
are  established  as  going  concerns  is  not  at  all  unusual,  but 
can  hardly  be  said  to  be  the  typical  procedure  in  most  lines 
of  business. 

1  Borrowing  for  the  purchase  of  productive  equipment  already  in 
existence  (land  or  other  goods)  manifestly  makes  no  difference  in  either 
the  demand  or  supply  of  capital  and  hence  has  no  effect  on  the  interest 
rate. 


328  RISK,  UNCERTAINTY,  AND  PROFIT 

The  importance  of  the  distinction  between  capital  and 
capital  goods  should  now  be  clear.  The  business  world 
thinks  of  capital  as  money  funds.  Money,  however,  is  only 
a  medium  of  exchange,  and  in  the  investment  function  rep- 
resents a  title  to  a  surplus  of  wealth,  practically  speaking 
a  surplus  of  consumption  goods.  This  is  the  real  meaning 
of  free  capital,  which  is  a  stage  in  the  development  of  capi- 
tal goods.  The  crux  of  current  confusion  in  interest  theory 
lies  in  the  failure  to  see  the  significance  of  the  fact  that  we 
live  in  a  progressive  society,  that  new  net  surplus  produc- 
tion is  constantly  flowing  through  the  loan  market  into  the 
investment  field  and  being  converted  into  material  equip- 
ment.1 That  is,  it  is  surplus  production  on  the  part  of  the 
individuals  and  classes  who  save  it;  from  the  standpoint  of 
society  as  a  whole  there  is  no  surplus  production  of  con- 
sumption goods;  the  surplus  appears  in  the  form  of  addi- 
tions to  capital  equipment.  In  an  unprogressive  society 
where  new  saving  was  not  being  used  to  create  new  re- 
sources, there  could  not  be  interest  in  the  sense  in  which 
the  term  has  significance  to  economic  theorists,  —  i.e., 
as  a  distributive  share,  —  though  interest  could  be  paid 
for  consumption  loans.  At  present  consumption  loans  are 
negligible  in  comparison  with  loans  for  conversion  into 
new  productive  goods;  when  they  are  made  they,  of  course, 
take  the  same  rate  of  interest,  allowance  being  made  for 
degree  of  security  against  loss  of  interest  and  principal.2 

Interest  is  the  payment  for  the  use  of  free  capital;  for 
the  use  of  capital  goods  when  employed  by  another  than 
their  owner,  the  payment  is  a  rent.  Interest  is  manifestly 

1  From  the  standpoint  of  an  ultimate  long-time  treatment  of  interest 
theory  it  is  important  that  this  conversion  is  not  usually  utterly  irrevo- 
cable. The  process  can  generally  be  reversed,  the  capital  withdrawn,  and 
the  wealth  recovered  in  the  form  of  consumption  goods  —  more  or  less 
quickly  and  effectively  —  by  under-maintenance  of  the  capital  goods. 

2  See  chapter  iv  for  a  discussion  of  the  possibility  that  interest  might 
appear  in  connection  with  the  use  of  property  in  a  static  state,  and  chap- 
ter v  for  a  similar  discussion  with  regard  to  a  progressive  society  with  un- 
certainty absent. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       329 

paid  out  of  the  produce  of  the  property  created  with  the 
resources  obtained  by  the  loan;  it  is  part  of  the  produce  of 
the  capital  goods  which  were  in  the  mind  of  the  borrower 
when  the  loan  was  made,  which  the  capital  represented  to 
him.  This  yield  of  property  must  again  be  distinguished 
from  rent ;  the  former  is  the  actual  return  realized  from  the 
exploitation  of  the  material  things,  while  rent  is  the  com- 
petitive market  value  of  their  use.  Rent  is  paid  out  of  the 
property  yield  if  the  property  is  actually  leased;  if  it  is 
managed  by  the  owner,  income  should  still  be  imputed  to 
it  on  the  basis  of  its  fair  rental  value.  The  yield  should  in- 
clude rent  plus  a  profit,  if  the  entrepreneur  is  to  get  any 
remuneration  for  the  performance  of  his  special  function.1 

These  three  species  of  income  thus  form  a  sort  of  con- 
catenated series,  tied  together  by  two  forms  of  profit.  The 
actual  yield  of  the  property  includes  the  competitive  rent, 
and  the  profit  which  pays  the  responsible  entrepreneur  who 
exploits  it.  The  rent  in  turn  includes  competitive  interest 
on  the  investment  (the  original  value  sacrificed  to  create  it) 
plus  a  profit  which  is  the  remuneration  for  the  entrepreneur 
function  of  converting  the  investment  into  the  concrete 
goods. 

One  striking  difference  between  rent  and  interest  has 
been  especially  fruitful  as  a  source  of  confusion  in  the 
theory.  Both  are  expressed  as  rates,  per  dollar  per  year, 
but  the  explanation  is  very  different  in  the  two  cases. 
Interest  is  naturally  a  rate,  a  ratio  between  two  values.  The 
object  transferred  from  saver  to  entrepreneur  is  expressed 
in  value  terms,  a  certain  amount  of  money,  representing 
surplus  consumers'  goods  to  a  certain  value,  and  the  return 
to  the  capitalist  is  also  stated  in  value  terms.  If  rent  is 
stated  as  a  rate  of  return  on  the  investment,  however,  the 
relation  is  inverse;  the  investment  in  this  case  means  not 

1  Whether  entrepreneurs  as  a  class  or  on  the  average  do  secure  re- 
muneration for  their  services  as  entrepreneurs  in  the  strict  sense  —  i.e., 
exclusive  of  payment  for  their  work  and  for  the  use  of  their  property  — 
is  a  point  about  which  question  will  be  raised  in  the  next  chapter. 


330  RISK,  UNCERTAINTY,  AND  PROFIT 

an  original  value  magnitude,  but  the  sale  value  of  the  prop- 
erty, which  is  the  result  of  capitalization  at  the  current 
rate  of  interest.  For  obviously  in  a  progressive  society 
where  men  are  constantly  lending  funds  of  value  at  interest, 
freedom  of  exchange  between  value  funds  and  productive 
goods  will  fix  a  value  on  the  latter  equal  to  the  investment 
necessary  to  produce  an  equivalent  return.  It  is  this  phe- 
nomenon of  capitalization  which  to  certain  writers  of  the 
"psychological  school"  1  has  obscured  the  fact  that  what 
is  transferred  in  a  loan  at  interest  is  a  fund  of  value  which 
is  not  the  result  of  a  capitalization  process,  but  is  valued  as 
an  immediate  utility. 

Capitalization  and  property  values  are  fundamental  to 
an  understanding  of  the  phenomena  which  arise  out  of  the 
uncertainties  present  in  a  progressive  society,  and  call  for 
some  further  discussion  on  their  own  account.  When  a  new 
productive  enterprise  is  once  established  and  shows  promise 
of  yielding  a  profit  above  the  competitive  rates  of  return  on 
the  resources  put  into  it  and  those  necessary  for  its  opera- 
tion, this  entire  future  yield,  discounted  to  its  present 
worth  at  the  current  rate  of  interest,  can  be  drawn  or 
cashed  in  at  once  by  the  sale  of  the  property.2  Taken  in 
conjunction  with  the  fact  observed  above,  that  the  desire 
to  own  productive  wealth  is  by  no  means  merely  an  in- 
direct desire  to  consume  its  revenue,  this  fact  of  the  an- 
ticipation of  future  income  by  capitalization  increases 
many  fold  the  incentive  to  embark  on  new  ventures.  Even 
when  the  owner  of  the  enterprise  has  no  intention  of  selling 

1  Time  preference  or  discount  of  the  future,  as  more  fully  explained 
elsewhere,  has  nothing  to  do  with  the  interest  rate  except  in  determining 
the  supply  of  new  capital  (rate  of  saving).  This  indirect  effect  becomes 
appreciable  only  over  long  periods  of  time,  since  the  saving  made  in  any 
short  period  is  negligible  at  best  in  comparison  with  the  total  investment 
previously  made,  or  more  strictly  that  part  of  this  total  which  retains 
some  degree  of  fluidity,  and  is  also  negligible  in  relation  to  the  total  de- 
mand for  capital  in  the  market. 

2  Allowance  must  be  made  for  the  uncertainty  of  the  permanence  of 
the  income. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       331 

the  property,  but  considers  only  operating  it  to  secure  an 
income,  the  paper  profit  on  the  capital  value  must  be  con- 
sidered a  part  of  his  remuneration  more  or  less  separable 
in  his  mind  from  the  profit  in  the  shape  of  an  income  above 
the  competitive  return  on  the  investment. 

It  would  be  hard  to  overestimate  the  error  involved  in 
the  psychological  interpretation  of  economic  motive  as 
desire  to  consume  goods  alone.  Even  the  desire  for  an  in- 
come is  not  simply  a  desire  to  consume.  For  societies,  or 
social  classes  in  any  society,  near  the  subsistence  margin, 
this  is  more  nearly  true.  Even  the  so-called  "subsistence 
margin,"  however,  in  any  advanced  society  like  the  United 
States  includes  probably  several  times  as  much  as  is  really 
necessary  to  gratify  the  animal  wants  and  maintain  health 
and  physical  efficiency.  This  does  not  mean  that  an  in- 
dividual can  really  live  on  a  fraction  of  what  those  with  the 
lowest  incomes  actually  consume,  for  in  a  civilized  society, 
the  conventional  necessaries  may  be  as  indispensable  in 
fact  as  the  animal  necessaries.  The  motives  for  the  con- 
sumption of  even  the  conventional  necessaries  are  none  the 
less  different  from  the  animal  needs.  The  desire  (or  neces- 
sity) for  conforming  to  conventions  is  not  the  same  thing  as 
the  need  for  food  and  protection;  the  easy  fallacy  is  con- 
fusion of  the  requirement  for  food,  clothing,  and  shelter 
of  the  conventional  kinds  with  the  requirement  for  food, 
clothing,  and  shelter  as  physiological  necessities.  A  large 
part  of  the  consumption  of  persons,  in  the  lower  income 
strata  even,  does  not  yield  satisfaction  as  consumption; 
the  motives  and  cravings  are  social  in  their  origin  and 
nature.  It  is  a  commonplace  that  many  of  the  necessities 
of  to-day  did  not  exist  or  were  not  available  for  our  an- 
cestors a  few  generations  ago,  irrespective  of  their  wealth. 

In  separating  the  desire  to  increase  one's  possessions 
from  the  desire  to  consume  goods,  we  of  course  make  no 
pretense  of  carrying  our  analysis  back  to  "ultimate" 
motives,  but  an  observation  in  this  connection  may  not  be 


332  RISK,  UNCERTAINTY,  AND  PROFIT 

out  of  place.  Adverse  reference  has  been  made  to  the  use  of 
instinct  psychology  in  economics.  In  the  writer's  view  the 
lists  of  instincts  given  by  Parker  and  others  are  superficial 
in  the  highest  degree;  yet  it  must  be  admitted  that  this 
literature  represents  progress,  in  comparison  with  the 
naive  psychologizing  of  conventional  economics.  The 
instincts  are  a  step  in  the  right  direction,  carrying  back  the 
immediate  lines  of  endeavor  to  more  generalized  motives 
and  impulses.  The  defect  in  the  procedure  is  that  it  stops 
halfway  on  the  road  to  a  rather  obvious  goal.  Man  has  no 
instincts  in  the  sense  of  tendencies  to  act  in  a  definite  way 
under  definite  circumstances,  at  least  above  a  plane  so  low 
that  they  are  as  properly  interpreted  as  reflexes.  He  has  a 
few  needs,  of  course,  but  the  knowledge  of  their  mode  of 
satisfaction  is  not  innate.  We  should  never  know,  if  un- 
taught, what  to  eat,  if  indeed  we  should  connect  the  pangs 
of  hunger  with  the  act  of  eating  at  all  in  the  absence  of 
knowledge  gained  by  teaching  through  stimulating  certain 
reflexes.  And  similar  statements  probably  hold  for  sex 
behavior.  It  seems  clear  that  in  our  whole  higher  life  above 
the  plane  of  food  and  sex  and  primitive  pleasure-pain  re- 
actions, our  activities  result  from  a  single  unspecified,  un- 
directed tendency  to  act  purposefully \  the  specific  direction 
of  the  desire  and  activity  being  determined  by  suggestion 
from  the  environment  and  critical  reflection  upon  such 
outside  suggestion.  All  the  instincts  not  directly  con- 
nected with  self-preservation  (and  the  specific  content  of 
even  these  as  we  have  seen  is  largely  taught)  are  easily 
analyzed  into  each  other;  any  one  of  them  —  or  better,  any 
pair,  for  they  run  largely  in  pairs  of  opposites  —  if  inter- 
preted broadly  will  account  for  most  of  our  conduct.  The 
only  differentiation  that  would  have  any  meaning  would 
be  the  separation  of  an  instinct  of  repose  from  the  instinct 
of  action;  and  repose  is  a  mere  negative. 

Possibly  thought  is  sometimes  enough  different  from 
motor  activity  to  justify  a  separation,  but  this  would  cer- 


UNCERTAINTY  AND  SOCIAL  PROGRESS       333 

tainly  be  the  case  with  exceptional  individuals  only,  and 
the  instinct  theorists  insist  on  universality  as  a  criterion 
for  a  true  instinct.1 

The  conclusion  we  are  here  interested  in,  however  inter- 
preted into  human  nature,  is  that  social  progress  on  the 
material  side  is  largely  motivated  by  a  desire  to  possess 
wealth,  and  that  the  role  of  uncertainty  in  connection  with 
capitalization  is  to  make  it  possible  for  an  individual 
through  superior  judgment  or  good  luck  to  obtain  a  large 
increase  in  his  wealth  in  a  short  time.  In  addition  capitali- 
zation brings  about  a  reduction  of  uncertainty  through 
consolidation,  in  a  way  pointed  out  in  an  earlier  chapter. 
Persons  who  are  fitted  for  and  enjoy  making  new  ventures 
can  specialize  in  this  type  of  economic  activity,  selling  the 
new  enterprises  when  established.  Thus  by  bringing  many 
ventures  within  the  scope  of  action  of  a  single  individual 
(or  business  unit)  the  errors  tend  more  or  less  to  cancel 
out;  and  an  estimate  can  be  formed  of  the  objective  value 
of  the  entrepreneur  ability  exemplified,  still  further  re- 
ducing the  margin  of  uncertainty  in  any  particular  venture. 

It  goes  without  saying  that  the  phenomena  of  capital- 
ization hold  good  for  established  enterprises  as  well  as 
new  ones.  Any  change  in  the  current  yield  of  any  pro- 
perty whatever  at  once  accrues,  in  so  far  as  it  is  viewed 
as  permanent,  in  the  form  of  a  change  in  the  capital  value 
of  that  property.  These  changes  in  capital  value  often 
overshadow  in  importance  the  changes  in  income.  Such 
changes  in  capital  values,  depending  on  the  anticipated 
future  income  of  the  property,  do  not  necessarily  wait  for 

1  The  correct  line  for  a  scientific  interpretation  of  human  behavior  is 
in  the  writer's  view  well  indicated  in  the  "Methodological  Introduction" 
(by  Professor  Thomas)  to  The  Polish  Peasant  in  Europe  and  America,  by 
Thomas  and  Czaniecki.  Professor  Thomas's  analysis  runs  in  terms  of 
"values"  (social  customs,  conventions,  or  mores)  and  "attitudes,"  the 
result  of  individual  criticism  of  the  established  values  and  tending  con- 
stantly to  modify  and  reconstruct  the  latter.  This  view  is  also  harmonious 
with  that  of  Professor  Tufts,  formulated  in  more  general  terms  in  the 
essay  on  "The  Moral  Life"  in  the  volume  entitled  Creative  Intelligence. 


234  RISK,  UNCERTAINTY,  AND  PROFIT 

ent  possible  outcomes  in  a  group  of  instances  is  known,  it 
is  possible  to  get  rid  of  any  real  uncertainty  by  the  expe- 
dient of  grouping  or  "consolidating"  instances.  But  that 
it  is  possible  does  not  necessarily  mean  that  it  will  be  done, 
and  we  must  observe  at  the  outset  that  when  an  individual 
instance  only  is  at  issue,  there  is  no  difference  for  conduct 
between  a  measurable  risk  and  an  unmeasurable  uncer- 
tainty. The  individual,  as  already  observed,  throws  his 
estimate  of  the  value  of  an  opinion  into  the  probability 
form  of  "a  successes  in  b  trials"  (a/b  being  a  proper  frac- 
tion) and  "feels"  toward  it  as  toward  any  other  probability 
situation. 

As  so  commonly  in  this  subject  fraught  with  logical 
difficulty  and  paradox,  reservations  must  be  made  to  the 
above  statement.  In  the  first  place,  it  does  not  matter  how 
unique  the  instance,  if  a  real  probability  can  be  calculated, 
if  we  can  know  with  certainty  how  many  successes  there 
would  be  in  (say)  one  hundred  trials  if  the  one  hundred 
trials  could  be  made.  If  we  know  the  odds  against  us  it 
does  not  matter  in  the  least  whether  we  place  all  our  wagers 
in  one  kind  of  game  or  in  as  many  different  games  as  there 
are  wagers;  the  laws  of  probability  hold  in  the  second  case 
just  as  well  as  in  the  first.  But  in  business  situations  it  so 
rarely  happens  that  a  probability  can  be  computed  for 
a  single  unique  instance  that  this  qualification  has  less 
weight  than  might  be  supposed.  However,  in  so  far  as  ob- 
jective probability  enters  into  a  calculation,  it  is  hard  to 
imagine  an  intelligent  individual  considering  any  single 
case  as  absolutely  isolated.  The  only  exception  would  be  a 
decision  in  which  one's  whole  fortune  (or  his  life)  were  at 
stake.  The  importance  of  the  contingency  and  probable 
frequency  of  recurrence  in  the  individual  lifetime  of  situa- 
tions similar  in  the  magnitude  of  the  issues  involved  should 
make  a  difference  in  the  attitude  assumed  toward  any  one 
case  as  well  as  the  mathematical  probability  of  success  or 
failure. 


METHODS  FOR  MEETING  UNCERTAINTY     235 

A  second  reservation  of  more  importance  is  connected 
with  the  possibility  referred  to  in  the  preceding  chapter,  of 
forming  classes  of  cases  by  grouping  the  decisions  of  a  given 
person.  That  is,  even  though  we  do  not  get  a  quantitative 
probability  by  the  process  of  grouping,  still  there  is  some 
tendency  for  fluctuations  to  cancel  out  and  for  the  result 
to  approach  constancy  in  some  degree.  There  appear  to 
be  in  the  making  of  judgments  the  same  two  kinds  of 
elements  that  we  find  in  probability  situations  proper; 
i.e.,  (a)  determinate  factors  (the  quality  of  the  judging 
faculty,  which  is  more  or  less  stable)  and  (b)  truly  acci- 
dental factors  varying  from  one  decision  to  another  accord- 
ing to  a  principle  of  indifference.  The  difference  between 
the  uncertainty  of  an  opinion  and  a  true  probability  is  that 
we  have  no  means  of  separating  the  two  and  evaluating 
them,  either  by  calculation  a  priori  or  by  empirical  sorting. 
But  in  the  second  case  the  difference  is  not  absolute;  the 
sorting  method  does  apply  to  some  extent,  though  within 
narrow  limits.  Life  is  mostly  made  up  of  uncertainties, 
and  the  conditions  under  which  an  error  or  loss  in  one  case 
may  be  compensated  by  other  cases  are  bafflingly  complex. 
We  can  only  say  that  "in  so  far  as"  one  confronts  a  situa- 
tion involving  uncertainty  and  deals  with  it  on  its  merits 
as  an  isolated  case,  it  is  a  matter  of  practical  indifference 
whether  the  uncertainty  is  measurable  or  not. 

The  problem  of  the  human  attitude  toward  uncertainty 
(not  for  the  present  purpose  distinguishing  kinds)  is  as 
beset  with  difficulties  as  that  of  uncertainty  itself.  Not 
merely  is  the  human  reaction  to  situations  of  this  character 
apt  to  be  erratic  and  extremely  various  from  one  individual 
to  another,  but  the  "normal"  reaction  is  subject  to  well- 
recognized  deviations  from  the  conduct  which  sound  logic 
would  dictate.  Thus  it  is  a  familiar  fact,  well  discussed  by 
Adam  Smith,  that  men  will  readily  risk  a  small  amount  in 
the  hope  of  winning  a  large  when  the  adverse  probability 
(known  or  estimated)  against  winning  is  much  in  excess  of 


336  RISK,  UNCERTAINTY,  AND  PROFIT 

waves.  It  is  like  the  oft-cited  advance  of  the  tide  up  a 
beach,  advance  and  recession  alternating  and  obscuring 
even  the  fact  that  a  small  gain  of  an  occasional  wave  con- 
stitutes a  net  advance.  Economic  progress  under  real  con- 
ditions shows  similar  advance  and  recession,  proceeding  in 
cycles  of  a  character  now  fairly  well  understood,  but  of  such 
uncertain  length  that  the  consequences  at  the  turning- 
points  are  often  catastrophic.  A  large  part  of  the  phenome- 
non is  due  to  the  fact  that  the  creation  of  new  capital  is  so 
closely  bound  up  in  the  issue  of  circulating  medium  by 
commercial  banks.  Price  levels  and  profit  margins  being 
even  more  dependent  on  this  precarious  exchange  medium, 
the  operations  of  business  proper  find  themselves  tied  up  to 
the  tendencies  of  a  credit  currency  under  private  control  to 
expand  to  a  point  of  instability  and  under  the  least  shock 
to  collapse.  These  phenomena  enormously  increase  the 
uncertainty  of  business  operations  and  create  opportunities 
for  making  large  gains  through  the  exercise  of  superior 
foresight  or  by  good  luck.1 

The  above  description  of  the  uncertainty  relations  of 
one  of  the  elements  of  social  progress,  brief  and  inadequate 
as  it  is,  must  suffice  for  the  present  sketch.  Moreover,  the 
other  progress  factors,  though  more  complicated  and  diffi- 
cult of  treatment,  will  have  to  be  disposed  of  very  briefly  by 
a  mere  indication  of  some  of  the  similarities  to  and  con- 
trasts with  the  growth  of  capital.  The  increase  of  popula- 
tion may  be  briefly  handled.  In  the  aggregate,  it  is  not 
subject  to  enough  uncertainty  to  produce  any  noticeable 
effect  on  the  organization  of  society.  Over  long  periods  the 
general  increase,  if  it  proceeds  faster  than  new  lands  are 
opened,  as  it  has  since  the  industrial  revolution,  causes  a 

1  Davenport  (Economics  of  Enterprise)  has  emphasized  the  fact  that 
the  short-period  changes  in  the  interest  rate  are  due  to  changes  in  the 
supply  of  bank  funds.  He  is  to  be  criticized  for  failing  to  make  it  clear 
that  the  long-time  questions  must  be  handled  along  wholly  different  lines. 
Cf.  also  Moulton,  "Commercial  Banking  and  Capital  Formation," 
Journal  of  Political  Economy,  1918,  pp.  484  ff.,  638  ff.,  705  ff.,  849  ff. 


UNCERTAINTY  AND  SOCIAL  PROGRESS       337 

rise  in  the  value  of  "land."  This  change,  however,  as  an 
aggregate  is  so  far  overshadowed  by  the  differences  in  the 
changes  at  different  locations  that  it  may  be  passed  over. 
There  is  little  question  that  in  fact  speculators  in  land 
make  on  the  whole  less  than  the  competitive  return  on  their 
investment,  though  this  is  difficult  to  prove  conclusively. 
The  outstanding  phenomenon  is  the  large  gains  and  losses, 
especially  the  large  gains  from  a  few  fortunate  investments 
in  real  estate  held  over  a  period  of  generations  by  the  same 
families.  We  shall  recur  to  this  theme  in  the  next  chapter. 
It  is  clear  that  the  main  cause  of  the  differential  rates  of 
value  increase  is  another  one  of  our  progress  factors,  the 
redistribution  of  the  population  over  the  soil.  The  mixture 
of  foresight  and  pure  luck  in  the  production  of  gains  from 
such  uncertainties  is  an  interesting  question,  but  one  about 
which  there  seems  to  be  little  comment  worth  making.  An- 
other phenomenon  in  connection  with  the  increase  of  pop- 
ulation over  long  periods  is  the  redistribution  of  wealth 
and  probably  of  ability  among  individuals.  We  know  that 
the  wealthier  families  increase  much  more  slowly  than  the 
less  wealthy,  and  there  is  every  reason  to  believe  that  the 
same  applies  to  the  more  as  compared  with  the  less  cap- 
able. As  wealth  and  ability  are  both  inherited  in  varying 
degrees  the  consequences  are  obtrusive,  in  their  general 
character  at  least.  These  facts  do  not  affect  the  form  or 
theory  of  competitive  organization,  but  as  they  modify  the 
material  upon  which  the  mechanism  works  the  results  are 
none  the  less  subject  to  change. 

Another  progress  factor,  the  increase  in  the  available 
supply  of  natural  resources,  has  been  referred  to  incidentally 
above,  and  as  the  relations  of  "land"  to  "capital"  were 
discussed  in  an  earlier  chapter,  this  topic  need  not  detain 
us  long.  Discovery  of  new  natural  wealth  may  result  from 
pure  accident,  in  which  case  its  value  is  all  pure  profit, 
which  in  consequence  of  the  principle  of  capitalization  may 
be  cashed  in  at  once  by  the  finder.   But  this  is  not  what 


338  RISK,  UNCERTAINTY,  AND  PROFIT 

usually  happens.  In  the  case  of  agricultural  land  the  con- 
ditions and  rewards  of  pioneering  are  fairly  ascertainable. 
If  any  profit  results  from  these  operations  it  is  an  exceptional 
case  or  else  it  is  remuneration  for  some  special  sacrifice 
undergone;  i.e.,  is  not  a  profit  at  all.  With  mineral  re- 
sources things  are  different.  Here  there  is  an  enormous 
amount  of  complete  unpredictability.  Under  old-fashioned 
methods  there  is  no  question  that  prospecting  for  the  pre- 
cious metals  involved  in  the  aggregate  enormous  losses. 
In  regard  to  other  minerals,  coal,  oil,  iron,  copper,  etc.,  the 
present  writer  has  no  ground  for  forming  an  opinion,  but 
would  " guess* '  that  the  search  for  these  things  being  less 
feverish,  the  accidental  gains  are  much  less  in  arrear  of  the 
losses.  Recently  the  search  for  precious  metals  has  been 
placed  on  a  much  more  scientific  basis  and  there  is  doubt- 
less in  the  aggregate  less  discrepancy  than  formerly  be- 
tween the  returns  realized  and  a  normal  competitive  re- 
turn on  the  resources  invested. 

The  point  which  calls  for  emphasis  is  that  where  the 
possibility  of  securing  wealth  by  the  discovery  of  natural 
resources  is  known,  along  with  something  of  the  operations 
and  outlays  required,  resources  will  be  attracted  into  the 
field  of  searching  for  them  in  accordance  with  men's  esti- 
mates of  the  chances  of  success  in  relation  to  the  outlays  to 
be  incurred.  The  quest  of  wealth  by  this  process  thus  be- 
comes to  those  engaged  in  it  an  ordinary  business  opera- 
tion, differing  from  the  routine  production  of  goods  for 
immediate  consumption  in  no  matter  of  principle,  though 
perhaps  affected  by  a  larger  degree  of  uncertainty.  And 
the  same  organization  devices  will  be  called  into  existence  to 
deal  with  the  uncertainty  present  —  large-scale  operations, 
the  use  of  insurance  where  possible  still  further  to  broaden 
the  base  of  the  calculations,  scientific  research  into  the 
conditions  of  prediction  and  control  of  results,  etc.  Entre- 
preneurs engaged  in  exploration  and  development  work 
bid  in  the  same  market  against  entrepreneurs  in  the  fields 


UNCERTAINTY  AND  SOCIAL  PROGRESS       339 

of  static  industry  for  the  same  fundamental  productive 
resources,  and  competition  must  fix  a  uniform  price  for 
both  uses  and  bring  about  the  same  tendency  to  equality  of 
cost  incurred  with  output  secured  over  the  whole  field  of 
investment. 

Another  factor  of  progress  having  exceedingly  complex 
uncertainty  relations  is  the  changes  in  human  wants. 
These  changes,  again,  may  just  happen,  accidentally,  or 
they  may  take  place  more  or  less  in  accordance  with  law 
and  hence  predictably,  or  they  may  be  deliberately  brought 
about  by  the  expenditure  of  resources  for  the  express  pur- 
pose of  effecting  such  a  change.  If  they  happen  unexpect- 
edly the  disturbances  in  incomes  and  capital  values  which 
result  must  be  classed  as  pure  profit  or  loss./fn  so  far  as 
they  can  be  foreseen,  no  profit  will  be  realized.  In  so  far 
as  they  result  from  a  deliberate  expenditure  of  resources, 
they  become  as  all  other  economic  operations.  The  amount 
of  profit  realized  will  then  depend  on  the  effectiveness  of 
competition  based  on  foreknowledge  of  the  results  of  the 
activity.  In  this  respect  the  "production"  of  wants  is  like 
the  production  of  goods.  In  fact,  as  we  have  previously 
observed,  the  advertising,  puffing,  or  salesmanship  neces- 
sary to  create  a  demand  for  a  commodity  is  causally  in- 
distinguishable from  a  utility  inherent  in  the  commodity 
itself.  ^ 

The  last  progress  factor  calling  for  notice  is  that  of 
knowledge,  or  what  may  be  designated  by  the  term  "in- 
vention" taken  in  a  broad  sense.  It  is  a  commonplace  fact 
that  one  of  the  chief  sources  of  uncertainty  in  business  life 
is  the  improvement  of  technological  processes,  methods  of 
organization,  and  the  like.  It  is  difficult  to  draw  a  rigid 
distinction  in  principle  between  the  discovery  of  new  facts 
and  the  production  of  change  in  the  facts  themselves  as 
objects  of  knowledge.  It  is  plain  that  the  finding  of  new 
natural  resources  is  equivalent  to  their  creation  and  the 
difference  in  the  case  of  human  wants  is  also  rather  hazy 


340  RISK,  UNCERTAINTY,  AND  PROFIT 

and  metaphysical.  The  important  "practical  difference 
between  discovery  and  creation  relates  to  the  matter,  re- 
ferred to  in  a  previous  chapter,  of  the  cost  of  reproduction 
of  ideas  as  compared  with  things.  The  knowledge  of  a  fact 
may  be  extensible  almost  without  cost  throughout  the 
membership  of  competitive  society.  Of  course  —  and  this 
is  an  observation  which  students  of  the  phenomena  have 
neglected  to  make  —  it  also  may  not  be  of  this  character; 
it  may  cost  as  much  to  get  an  idea  into  a  head  as  it  does 
to  get  matter  from  one  form  into  another,  and  it  always 
does  cost  some  expenditure  of  energy  somewhere.  In 
general,  however,  a  competitor  can  get  the  idea  of  a  new 
method  or  process  at  less  cost  than  he  can  get  new  material 
equipment,  provided  energy  is  not  expended  in  preventing 
him  from  doing  it.  Moreover,  the  mere  gratification  of 
curiosity  may  be  ample  compensation  for  the  effort  re- 
quired to  get  an  idea,  so  that  this  cost  can  be  entirely 
neglected  or  may  even  become  negative. 

The  essential  facts  about  new  knowledge  for  our  pur- 
poses center  around  the  qualities  of  the  productive  equip- 
ment, including  laborers,  requisite  for  carrying  it  into 
effect.  A  new  process  usually  calls  for  changes  in  the  forms 
and  attributes  of  productive  agencies  and  necessarily  in- 
volves new  combinations  among  these.  In  very  simple 
cases,  however,  little  may  be  involved  beyond  new  manipu- 
lations of  old  things.  Like  all  the  other  phases  of  progress 
this  one  may  result  from  accident  or  from  the  planned  ex- 
penditure of  existing  resources.  Even  in  the  case  of  ac- 
cident we  cannot  say  that  anticipation  of  and  allowance  for 
the  change  is  entirely  eliminated.  For  it  is  not  meaningless 
to  assert  that  even  of  things  beyond  our  knowledge  or 
control  some  are  more  likely  to  happen  than  others.  We  do 
make  such  judgments  and  in  the  large  they  are  probably 
more  right  than  wrong,  however  mysterious  may  be  the 
basis  upon  which  their  value  rests.  In  so  far  as  the  prob- 
ability of  a  discovery  can  be  estimated  it  is  evident,  as  in 


UNCERTAINTY  AND  SOCIAL  PROGRESS       341 

the  case  of  progressive  changes  previously  discussed,  that 
entrepreneurs  will  make  allowance  for  its  effects  and  in  so 
far  it  will  in  the  aggregate  cause  no  competitive  maladjust- 
ment and  produce  no  discrepancy  between  the  prices  paid 
by  entrepreneurs  for  productive  services  and  the  prices 
received  for  their  products.  The  value  of  such  estimates  is 
naturally  very  small,  and  we  may  assume  that  most  of  the 
offsetting  of  gains  and  losses  from  disturbances  due  to 
accidental  discoveries  is  itself  accidental  and  not  the  result 
of  calculation. 

In  the  case  of  new  knowledge  which  is  the  result  of 
deliberate  thought,  investigation,  and  experiment,  the 
element  of  predictability  is  of  course  greater.  As  inscrutable 
as  with  accidental  discoveries,  almost,  are  the  operations 
by  which  we  form  an  estimate  of  the  chances  of  success  in 
such  operations,  but  the  fact  is  inescapable  that  we  do 
form  such  estimates  and  that  they  have  considerable  value. 
Much  scientific  and  business  research  is  now  carried  on 
under  some  approximation  to  competitive  conditions  by  the 
employment  of  large-scale  methods.  That  is,  it  is  possible  to 
foresee  the  average  long-run  results  of  the  operations  with 
sufficient  accuracy  to  cause  the  employment  of  resources  in 
the  field  up  to  a  point  where  the  return  is  approximately 
equated  with  the  return  from  the  same  resources  in  the 
general  competitive  market.  In  any  case  it  is  clear  that  in 
so  far  as  the  results  can  be  predicted  the  investment  of  re- 
sources in  the  acquisition  of  new  knowledge  will  be  so  ad- 
justed as  to  equate  the  return  with  the  general  competitive 
level,  which  is  to  say  equate  realized  values  to  costs  and 
eliminate  profits. 

The  matter  is  indeed  frequently,  if  not  usually,  com- 
plicated by  the  very  low  cost  of  indefinitely  multiplying  an 
idea  when  it  is  once  secured.  As  a  consequence  of  this  fact 
the  inventor  or  discoverer  usually  has  to  make  some  special 
provision  to  limit  the  use  of  his  results  to  his  own  business 
operations.  In  certain  fields  this  can  be  done  through  legal 


342  RISK,  UNCERTAINTY,  AND  PROFIT 

protection  granted  by  the  State  in  recognition  of  the  value 
to  society  of  the  service.  In  others  artificial  measures  for 
secrecy  must  be  taken.  In  many  cases  no  direct  safeguards 
are  available  and  the  economic  profitableness  of  the  idea  is 
limited  to  the  period  of  time  required  for  competitors  to 
copy  the  new  method.  Regular  commercial  research  in 
these  fields  is  doubtless  rare.  Even  legal  protection  is  valid 
only  for  a  limited  period  of  time  and  secrecy  cannot  often 
be  permanently  maintained.  When  the  idea  becomes 
common  property  it  is  like  any  other  superabundant 
element  in  production,  a  free  good  and  no  longer  a  pro- 
ductive factor  in  the  effective  economic  sense. 

It  may  often  happen,  however,  that  one  of  the  results  of  a 
new  departure  is  greatly  to  increase  the  value  of  some  lim- 
ited kind  of  material  or  human  productive  service.  If  this 
service  be  that  of  a  non-reproducible  natural  agent  the 
inventor  may  permanently  secure  that  part  of  the  value  of 
his  idea  by  purchasing  such  property.  If  the  gain  attaches 
to  reproducible  property  he  may  prolong  his  differential 
gain  by  the  period  required  to  increase  the  supply,  and 
even  in  case  of  a  specialized  human  service  a  long-time 
contract  may  sometimes  be  utilized  to  retard  diffusion  of 
the  results  of  superior  methods.  As  observed  in  our  dis- 
cussion of  monopoly  it  is  immaterial  whether  we  regard 
these  cases  as  monopolization  of  the  idea  or  method  as  such 
or  as  monopolization  of  the  limited  resources  necessary  for 
its  exploitation.  The  losses  which  are  equally  likely  to  re- 
sult from  inventions  fall  upon  the  owners  of  the  specialized 
human  qualities  or  equipment  goods. 

Discussion  of  the  conditions  of  permanence  of  the  gains 
from  improved  methods  of  production  leads  naturally  to 
the  consideration  of  the  general  subject  of  economic 
friction  and  its  opposite,  mobility.  We  have  already  ob- 
served that  the  advocates  of  the  "dynamic"  theory  of 
profit,  the  theory  that  profit  is  the  result  of  progressive 
change,  give  an  exceedingly  important  place  to  the  phenom- 


UNCERTAINTY  AND  SOCIAL  PROGRESS       343 

enon  of  friction  in  their  analysis.1  In  this  view,  indeed, 
friction  is  a  necessary  condition  to  the  occurrence  of  pro- 
fit, as  it  is  expressly  stated  that  in  the  absence  of  friction 
profit  would  disappear  as  fast  as  it  appeared  and  that  it 
does  constantly  slip  through  the  fingers  of  the  entrepre- 
neur and  spread  over  society  at  large  as  fast  as  the  friction 
can  be  overcome. 

It  will  be  apparent  as  soon  as  pointed  out  that  this  ar- 
gument uses  "friction"  in  an  inadmissibly  inclusive  sense. 
To  explain  profit  thus  in  terms  of  friction,  the  term  must 
be  made  to  cover  every  form  of  resistance  to  change  and 
readjustment  in  productive  operations.  That  is,  to  get  rid 
of  profit  by  eliminating  friction,  it  would  be  necessary  not 
merely  to  have  a  perfect  market,  perfect  competition,  and 
costless  mobility,  but  in  addition  it  would  have  to  be  possi- 
ble without  the  consumption  of  time  or  effort  to  change  the 
form  of  capital  equipment  and  goods  in  process,  not  to 
speak  of  natural  agencies  and  the  existing  labor  force.  In  a 
world  where  this  could  be  done,  it  is  manifest  that  there 
would  be  no  need  for  productive  effort  of  any  kind.  Per- 
haps we  may  distinguish  between  the  readjustments  in- 
volving only  the  moving  about  and  recombination  of  pro- 
ductive agencies  of  all  kinds  and  those  calling  in  addition 
for  substantial  alteration  in  the  form  of  things.  The  latter 
it  is  clearly  inadmissible  to  class  under  the  head  of  over- 
coming "friction."  But  the  same  may  be  said  even  of 
mere  movement  of  things.  This  also  is  a  productive  trans- 
formation, and  undoubtedly  the  greater  part  of  ordinary 
productive  activity  comes  under  the  head  of  transporta- 
tion, taken  in  a  broad  sense. 

It  is  necessary  to  take  up  the  problem  under  the  heads 
of  the  different  types  of  production  costs  and  investigate 
the  forces  which  retard  the  readjustment  of  each  type  to 
correspondence  with  the  value  of  the  productive  contribu- 
tion of  the  agency  to  which  the  payment  is  made.  The 
1  Cf .  above,  p.  34  f. 


S44  RISK,  UNCERTAINTY,  AND  PROFIT 

first  and  simplest  readjustment  is  that  of  values  of  services 
which  undergo  no  change  in  either  form  or  position  as  a 
result  of  the  introduction  of  new  methods.  A  new  dis- 
covery will,  as  already  noted,  increase  the  value  contribu- 
tions obtainable  by  the  use  of  some  agencies  and  decrease 
those  of  others.  It  will  ordinarily  be  true  that  changes  in 
the  market  prices  of  these  services  will  lag  appreciably  be- 
hind the  changes  in  their  theoretical  values  to  the  entre- 
preneur. Many  of  them  are  hired  under  contracts  cover- 
ing a  longer  or  shorter  period  of  time  which  prevent  sudden 
changes  in  their  rate  of  remuneration.  During  any  such 
interval  the  employing  entrepreneur  must,  of  course,  make 
a  gain  or  loss  by  their  use. 

And  even  where  the  factor  of  a  time  contract  does  not 
enter,  there  will  probably  be  a  lag  in  the  prices  of  produc- 
tive services,  i.e.,  in  the  costs  of  production,  as  compared 
with  commodity  prices.  The  former  are,  of  course,  in  the 
aggregate  caused  by  and  reflected  from  the  latter  and  the 
forces  of  competition  which  impute  commodity  values  to 
the  productive  services  upon  which  production  depends  do 
not  operate  instantaneously.  The  chief  cause  of  this  lag  is 
again  the  difficulty  and  uncertainty  of  knowledge;  it  takes 
the  owners  of  productive  services  and  entrepreneurs  some 
time  to  learn  the  facts.  Most  of  this  learning  has  to  be  done 
by  crude  and  rather  slow  trial-and-error  methods;  there  is 
generally  no  possibility  of  computing  results  in  advance.  In 
the  interval  necessary  for  every  one  to  find  out  the  exact 
relations  of  dependence  between  product  values  and  the 
employment  of  each  resource  and  of  working  out  an  ideal 
adjustment,  it  is  clear  that  there  will  be  many  discrepancies 
between  entrepreneurs'  outlays  and  their  returns,  i.e., 
many  occurrences  of  profit,  positive  or  negative. 

A  somewhat  special  case  is  presented  by  goods  in  pro- 
cess when  new  methods  are  introduced.  The  general  tend- 
ency must  be  to  decrease  the  values  of  most  of  these, 
though  not  necessarily  of  all.    The  loss  will  fall  on  the 


UNCERTAINTY  AND  SOCIAL  PROGRESS        345 

owner  in  whose  hands  they  are  when  the  price  change 
takes  place,  which  may  not  be  the  owner  at  the  time  the 
new  process  is  invented,  for  these  price  changes  will  also 
lag  more  or  less.  The  loss  in  value  will  depend  on  several 
factors,  the  amount  of  superiority  of  the  new  process  over 
the  old,  the  amount  of  difference  between  the  old  inter- 
mediate goods  and  the  corresponding  new  ones,  and  the 
possibility,  and  the  cost,  of  changing  the  old  intermediate 
goods  in  a  way  to  have  the  manufacture  carried  to  comple- 
tion by  the  new  process. 

Material  productive  goods  will  fall  more  or  less  under 
the  same  head  as  goods  in  process  according  as  they  are  or 
are  not  reproducible,  short-lived,  and  amenable  to  change 
in  form.  We  have  seen  that  the  difference  between  capital 
and  land  is  one  of  degree,  depending  on  these  qualities  in 
the  agent.  At  one  extreme,  capital  is  typified  by  goods  in 
process.  At  the  other,  "land"  consists  of  these  agencies 
whose  supply  is  most  rigidly  fixed,  the  nearest  approach  to 
the  theoretical  limit  being  the  element  of  site  value.  Tak- 
ing this  extreme  first,  a  piece  of  pure  land  will  gain  or  lose 
the  capitalized  value  of  the  change  in  its  income  as  soon  as 
this  is  accurately  adjusted.  With  ordinary  capital  equip- 
ment, allowance  must  be  made  for  the  life  of  the  agency 
and  also  for  the  possibility  and  cost,  including  the  time  re- 
quired, to  adapt  it  to  the  new  conditions.  The  adaptation 
may  include  both  movement  from  one  situation  to  another 
and  change  in  form.  Even  a  revolutionary  invention, 
making  buildings  and  machinery  worthless  for  use  in  their 
present  form,  does  not  usually  destroy  all  their  value.  At 
worst  a  scrap  value  of  the  material  is  recoverable  of  the 
original  free  capital  invested  in  them. 

Laborers  present  a  still  different  case.  The  only  thing  to 
be  considered  from  the  standpoint  of  economic  organiza- 
tion is  here  the  lag  in  the  readjustment  of  wages  to  the  new 
real  value  of  labor.  Changes  in  the  value  of  specialized  skill 
accrue  to  the  laborer  as  an  individual  only  and  cannot  be 


346  RISK,  UNCERTAINTY,  AND  PROFIT 

capitalized.  The  same  facts  as  to  possibility  of  readapta- 
tion  hold  good  as  in  case  of  material  equipment  goods,  but 
again  this  is  a  matter  of  the  individual's  own  personal 
economy  and  does  not  affect  entrepreneurs.  The  peculiari- 
ties of  labor  in  relation  to  readjustments  form  one  of  the 
main  sources  of  injustice  and  hardship  in  an  individualist 
economy.  The  risk  of  loss  in  the  value  of  acquired  knowl- 
edge and  training  means  a  constantly  impending  threat  of 
indigence.  Laborers  are  attached  to  their  homes  and  even 
to  their  work  by  sentimental  ties  to  which  market  facts 
are  ruthless.  But  these  matters  hardly  call  for  detailed  dis- 
cussion in  a  study  of  the  present  sort. 


CHAPTER  XII 

SOCIAL  ASPECTS  OF  UNCERTAINTY  AND  PROFIT 

Uncertainty  is  one  of  the  fundamental  facts  of  life.  It  is 
as  ineradicable  from  business  decisions  as  from  those  in 
any  other  field.  The  amount  of  uncertainty  may,  however, 
be  reduced  in  several  ways,  as  we  have  seen.  In  the  first 
place,  we  can  increase  our  knowledge  of  the  future  through 
scientific  research  and  the  accumulation  and  study  of  the 
necessary  data.  To  do  this  involves  cost,  the  expenditure 
of  resources  which  must  be  drawn  from  other  uses.  An- 
other way  is  by  the  clubbing  of  uncertainties  through  large- 
scale  organization  of  various  forms.  This  operation  also 
involves  costs,  and  not  merely  in  the  sense  of  expenditure 
of  resources.  There  is  also  to  be  considered  the  loss  of 
individual  freedom  involved  in  any  possible  plan  of  or- 
ganization, a  loss  for  the  great  mass  of  persons  affected, 
though  possibly  a  gain  for  a  few  who  may  secure  wider 
powers  and  a  larger  range  of  action  from  the  concentration 
of  authority. 

In  the  third  place  it  is  possible,  also  at  a  cost,  to  increase 
control  over  the  future.  And  here  again  both  sorts  of  costs 
must  be  faced,  substantive  outlays  and  human  losses 
through  organization.  Finally,  uncertainty  might  be  fur- 
ther reduced  almost  indefinitely  by  slowing  up  the  march 
of  progress,  which,  of  course,  involves  a  direct  sacrifice  in 
addition  to  both  the  forms  of  cost  already  noticed. 

All  these  proposals  raise  the  fundamental  issue  as  to  the 
essential  evil  of  uncertainty,  how  great  it  is  and  hence  how 
much  we  can  afford  to  sacrifice  in  other  ways  in  order  to 
reduce  it.  In  this  sort  of  calculation  as  in  all  economic 
problems  we  are  dealing  with  a  question  of  proportioning 
alternatives  subject  to  a  principle  of  diminishing  relative 


348  RISK,  UNCERTAINTY,  AND  PROFIT 

importance.  It  would  doubtless  be  possible  to  use  all  the 
resources  of  society  with  more  or  less  effect  in  reducing  un- 
certainty, leaving  none  for  any  other  use.  It  is  a  question  of 
how  far  to  go.  The  question  is  complicated  by  the  fact 
that  the  use  of  resources  in  reducing  uncertainty  is  an  opera- 
tion attended  with  the  greatest  uncertainty  of  all.  If  we 
are  uncertain  as  to  the  results  of  ordinary  business  opera- 
tions we  are  doubly  so  as  to  the  results  of  expenditures 
along  any  of  the  lines  enumerated  looking  toward  the  in- 
crease of  knowledge  and  control. 

Quite  as  important  as  the  question  of  reducing  uncer- 
tainty is  that  of  its  distribution.  This  question  raises  again 
the  same  fundamental  issue,  this  time  from  the  individual 
point  of  view  instead  of  the  social,  as  to  the  intrinsic  desir- 
ability of  reducing  uncertainty.  How  far  the  burden 
should  be  equalized,  how  far  concentrated  or  specialized, 
depends  on  the  individual  attitude  toward  uncertainty, 
and  especially  on  the  tendency  of  the  irksomeness  to 
increase  as  the  amount  of  uncertainty  faced  by  an  individ- 
ual increases,  and  vice-versa.  The  steeper  the  curve  of  in- 
creasing disutility  the  more  we  must  favor  a  relative  dis- 
persion of  the  burden.  It  is  perhaps  obvious  that  high 
degrees  of  "risk"  are  more  irksome;  most  of  us  are  reluc- 
tant to  jeopardize  our  lives  or  the  elemental  requirements 
of  life.  But  it  is  also  evident  that  individuals  differ  widely 
in  the  extent  to  which  they  find  this  true.  We  have  already 
noted  the  more  or  less  paradoxical  fact  that  the  very  idea  of 
intelligent  conduct  implies  an  effort  to  reduce  uncertainty, 
while  none  the  less  we  recognize,  on  any  calm,  cool  contem- 
plation of  the  matter,  that  a  life  with  uncertainty  elimin- 
ated or  perhaps  even  very  greatly  reduced  would  not  appeal 
to  us. 

There  is  a  close  connection  between  the  two  notions,  re- 
ducing the  absolute  amount  of  uncertainty  on  the  whole 
and  distributing  it,  for  most  methods  of  reducing  it  effect 
either  a  concentration  or  a  distribution.  On  this  head  there 


SOCIAL  ASPECTS  849 

seems  to  be  no  generalization  which  can  be  made  with 
confidence  and  which  is  worth  making. 

It  is  not  too  much  to  say  that  the  very  essence  of  free 
enterprise  is  the  concentration  of  responsibility  in  its  two 
aspects  of  making  decisions  and  taking  the  consequences 
of  decisions  when  put  into  effect.  It  is  therefore  of  the  ut- 
most importance  to  inquire  critically  and  carefully  into  the 
facts  as  to  the  results  of  such  a  concentration  in  compari- 
son with  any  possible  alternatives.  At  the  outset  we  shall 
raise  no  question  as  to  large-scale  industry;  and  it  is  evi- 
dent that  if  we  are  to  have  large-scale  organization  with  its 
advantages  in  efficiency  we  must  assume  a  corresponding 
degree  of  concentration  of  control  in  the  immediate  sense 
of  executive  direction.  This,  however,  as  we  have  been 
especially  concerned  to  emphasize,  does  not  necessarily 
mean  concentration  of  responsibility.  We  have  seen  that 
practically  all  human  activity,  even  that  of  the  purest 
routine  character,  is  in  some  manner  and  degree  forward- 
looking  and  involves  meeting  unexpected  situations  and 
making  decisions.  But  these  decisions  do  not  necessarily 
involve  responsibility.  The  outstanding  feature  of  free 
enterprise  organization  is  the  transfer  of  the  lower  grades 
of  responsibility  to  men  whose  decisions  relate  to  the  selec- 
tion of  men  for  the  places  under  their  control  and  to  answer- 
ing occasional  questions  in  regard  to  exceptional  contin- 
gencies. The  two  functions  are,  indeed,  never  quite  sepa- 
rate. The  ultimate  responsibility  consists  chiefly  in  the 
selection  of  a  man  or  a  very  few  men  to  "organize"  the 
establishment.  But  the  ultimate  authority  usually  if  not 
always  exercises  some  direct  control  over  business  policy. 
In  most  cases  also  the  higher  officials  of  an  enterprise  have 
a  direct  stake  in  the  business  beyond  their  fixed  salaries. 
And  down  through  the  organization  the  subordinate  func- 
tionaries may  be  said  to  have  responsibility  in  the  sense 
that  the  results  which  they  secure  must  come  up  to  the  ex- 
pectations of  their  superiors  or  they  will  lose  their  positions. 


350  RISK,  UNCERTAINTY,  AND  PROFIT 

In  the  existing  system  of  things  the  ultimate  responsi- 
bility centers  almost  altogether  in  the  ownership  of  the 
property  "at  risk"  in  the  business.  There  are  infinite  vari- 
ations and  complications  in  the  distribution  of  "risk"  and 
control,  but  the  general  tendency  is  clear.  The  lower  grades 
of  labor  take  practically  no  risk  and  exercise  correspond- 
ingly little  control,  and  the  same  is  only  less  true  of  the 
higher  grades  and  of  borrowed  capital.  We  must  remember 
that  the  two  things,  uncertainty-bearing  and  responsible 
control,  are  inseparable;  in  so  far  as  the  reward  of  any 
service  is  contingent  upon  the  success  of  the  undertaking, 
the  owner  of  that  service,  in  consenting  to  its  employment 
for  a  contingent  remuneration,  exercises  judgment  and 
wields  power  over  the  enterprise.  But  the  greater  part  of 
the  uncertainty  and  power  are  centered  in  the  ownership 
of  certain  property  which  is  placed  in  the  position  of  guar- 
anteeing the  contractual  income  of  the  other  property  and 
that  of  the  labor  used  in  the  business.1 

1  Limited  progress  has  been  made  in  some  countries  in  the  development 
of  organizations  of  laborers  which  engage  in  enterprise  independently, 
borrowing  any  necessary  capital  and  hiring  supervision  at  fixed  rates. 
Cooperative  production  in  the  ordinary  sense  may  also  be  referred  to,  but 
neither  of  these  cases  affords  a  notable  exception  to  the  above  generaliza- 
tion as  the  laborers  borrow  very  little  capital.  It  is  one  of  the  defects  of 
our  civilization  that  mechanism  has  not  been  involved  to  enable  human 
ability  to  hypothecate  its  productive  power  in  procuring  resources  to 
make  it  effective  under  its  own  direction  and  responsibility. 

A  notable  tendency  in  modern  business  development  is  to  specialize 
and  subdivide  uncertainty  and  control  in  all  possible  degrees.  Corpora- 
tions multiply  securities  representing  every  conceivable  gradation  from 
the  position  of  a  pure  creditor  with  absolute  safety  and  complete  indiffer- 
ence to  the  conduct  of  the  business  at  one  extreme  to  risk  and  control  so 
highly  concentrated  that  slight  fluctuations  in  earnings  make  the  differ- 
ence between  high  dividends  and  assessments  at  the  other.  In  mercantile 
business  and  even  in  industrial  concerns  credit  instruments  pass  through 
the  hands  of  a  lengthening  series  of  middlemen  who  add  their  guarantees 
of  soundness  and  pass  them  on  at  a  little  higher  price  or  lower  return. 
Bond  houses,  bill  brokers,  and  acceptance  banks  are  an  interesting  de- 
velopment in  this  field.  In  the  labor  field  the  same  tendency  is  manifest. 
Intermediate  employers  may  hire  labor  for  re-hiring  to  actual  exploiters, 
as  in  the  familiar  case  of  the  padrone,  and  in  some  lines  of  professional 


SOCIAL  ASPECTS  351 

We  shall  not  attempt  to  take  up  all  the  possible  or  actual 
arrangements  in  regard  to  responsibility  and  control,  but 
shall  limit  the  discussion  to  the  general  problem  of  con- 
centration of  uncertainty.  It  will  be  kept  in  mind  that  the 
basis  of  effective  assumption  of  responsibility  is  necessarily 
either  the  ownership  of  property  or  the  creation  of  a  lien  on 
future  human  productive  power  and  is  in  fact  almost  alto- 
gether the  former.  Another  preliminary  reservation  is  that 
in  a  sense  ultimate  control  rests  with  the  consumer.  But 
in  so  far  as  economic  organization  takes  the  form  of  free 
enterprise  this  control  is  exercised  only  after  the  fact,  and 
the  responsibility  we  are  concerned  with  is  that  of  meeting 
the  consumer's  demands  at  the  end  of  the  production  proc- 
ess. We  assume,  then,  that  the  entrepreneur  system  of 
organization,  with  production  for  the  market  imperson- 
ally, and  concentration  of  direction,  arises  because  it  is 
superior  to,  or  more  satisfactory  all  around  than  any  other 
free  contract  system.  And  the  first  step  in  our  inquiry  will 
be  a  brief  examination  into  the  meaning  of  free  contract. 

With  the  possible  exception  of  the  word  "cause"  and  its 
equivalents,  it  is  doubtful  if  there  is  a  more  abused  word 
than  "freedom";  and  surely  there  is  no  more  egregious 
confusion  in  the  whole  muddled  science  of  politics  than 
the  confusion  between  "freedom"  and  "freedom  of  con- 
tract."1 Freedom  refers  or  should  refer  to  the  range  of 
choices  open  to  a  person,  and  in  its  broad  sense  is  nearly 
synonymous  with  "power."  Freedom  of  contract,  on  the 
other  hand,  means  simply  absence  of  formal  restraint  in 
disposal  of  "one's  own"  It  may  mean  in  fact  the  perfect 
antithesis  of  freedom  in  the  sense  of  power  to  order  one's 
life  in  accordance  with  one's  desires  and  ideals.  The  actual 
content  of  freedom  of  contract  depends  entirely  on  what 
one  owns. 

work.  Every  development  of  profit-sharing  is  similarly  a  redistribution  of 
risk  and  control. 

1  Sir  H.  S.  Maine  and  Herbert  Spencer  are  especially  responsible  for 
this  vicious  and  question-begging  perversion  of  thought. 


352  RISK,  UNCERTAINTY,  AND  PROFIT 

Ownership,  as  we  have  seen,  consists  essentially  of  the 
combination  of  the  rights  of  control  and  of  usufruct.  The 
point  to  be  emphasized  here  is  that  in  a  social  system  based 
on  pure  freedom  of  contract,  ownership  and  control  are 
interchangeable  terms;1  there  is  no  other  form  of  control. 
To  be  sure,  there  would  have  to  be  a  "state"  of  some  sort, 
an  authoritative  organization,  to  maintain  such  a  system, 
but  its  sole  function  would  be  the  enforcement  of  contract 
and  prevention  of  non-contractual  relations.  Its  necessity 
arises  from  the  fact  that  contracts  are  not  often  executed 
on  both  sides  simultaneously  and  the  further  fact  that  men 
might  prey  upon  each  other.  That  is,  the  role  of  the  State 
in  such  a  system  would  be  merely  to  restrict  human  rela- 
tions to  the  mutually  voluntary,  or  contractual.  In  such  a 
system,  to  repeat,  those  who  owned  nothing  could  not 
exist  unless  by  the  sufferance  and  generosity  of  those  who 
did  own,  and  the  amount  of  freedom  possessed  by  any  per- 
son would  be  equal  to  the  amount  of  his  ownership. 

Now,  what  one  owns  is  under  ideally  simple  conditions  a 
result  of  three  factors.  The  first  and  by  far  the  most  im- 
portant is  the  historical  "brute  fact"  of  what  he  has  "to 
begin  with,"  his  inheritance  from  the  past.  This  is  purely 
a  matter  of  status  —  hence  the  fundamental  absurdity  of 
Maine's  contrast  between  status  and  contract  as  descrip- 
tions of  the  position  and  condition  of  the  individual.  All 
free  contract  can  mean  is  that  status  can  be  changed  by 
voluntary  agreement  with  another  party,  and  cannot  be 
changed  without  one  's  consent.  The  second  factor  in  owner- 
ship is  thus  the  result  of  previous  contracts.  And  the 
possibility  of  change  in  status  by  mutually  voluntary  agree- 
ment depends  on  one's  status  —  i.e.,  what  one  owns  —  at 

1  It  is  obvious  that  pure  freedom  of  contract  is  impossible  in  a  con- 
tinuous society,  as  children  and  the  aged  and  many  others  can  control 
nothing.  In  order  to  deal  with  the  concept  in  a  pure  form  we  are  com- 
pelled (see  chapter  iv)  to  assume  that  all  dependent  persons  were  ab- 
solutely dependent,  which  is  to  say  virtually  "owned"  by  the  freely  con- 
tracting members  of  the  society. 


SOCIAL  ASPECTS  353 

the  time  of  the  agreement,  and  hence  finally  on  what  one 
owned  to  begin  with.  The  third  factor  in  ownership  or 
present  status  is  change  resulting  from  the  voluntary  and 
independent  employment  or  transformation  by  utilization  of 
one's  own  in  the  past.  This  element  is  also  clearly  a  matter 
of  change  only,  going  back  to  initial  status  or  what  one 
owned  to  begin  with.  In  a  pure  free  contract  system  there 
is  no  power  (control)  except  ownership;  only  change  in 
ownership  (which  is  to  say  really  in  status)  has  any  con- 
nection with  the  exercise  of  free  choice,  and  the  range  of 
choice  depends  absolutely  on  previous  status  and  hence 
ultimately  on  the  initial  status  in  which  the  individual  finds 
himself  on  his  first  entry  into  the  system  of  contracting 
persons. 

All  the  above,  however,  assumes  that  contracts  and  the 
activity  directed  to  increasing  ownership  by  "productive" 
transformation  of  what  one  already  owns  are  intelligently 
carried  out.  In  the  world  as  it  is,  where  all  human  designs 
and  acts  are  fraught  with  uncertainty,  a  fourth  factor  must 
be  added,  the  result  of  luck.  Furthermore,  we  are  still  as- 
suming complete  independence  and  non-interference  among 
the  contracts  and  activities  of  different  individuals.  In  the 
world  as  it  is  the  interests  affected  by  contracts  are  never 
all  represented  in  the  agreements.  This  is  really  a  limita- 
tion on  the  assumption  of  pure  freedom  of  contract,  a  fail- 
ure to  restrict  human  relations  to  the  mutually  voluntary 
sphere,  but  it  is  a  fact  which  has  to  be  taken  into  account, 
like  deliberate  predation. 

These  facts  are  so  obtrusive  that  no  one  has  in  practice 
ever  advocated  pure  freedom  of  contract,  the  restriction  of 
the  action  of  society  as  a  whole  to  the  negative  function  of 
preventing  non-contractual  relations.  No  question  is  ever 
actually  raised  as  to  the  State  limiting  freedom  of  contract 
in  many  directions  and  encouraging  agreements  of  other 
sorts.  It  also  necessarily  appropriates  through  taxation 
a  considerable  part  of  the  usufruct  of  things  privately 


354  RISK,  UNCERTAINTY,  AND  PROFIT 

"owned,"  thus  modifying  ownership  in  both  its  phases. 
And  this  modifying  influence  on  private  property  extends 
rapidly  in  scope  as  the  laissez-faire  theory  of  the  State  loses 
ground  in  the  modern  world. 

It  is  a  fundamental  fact  that  the  possible  objects  of 
ownership  fall  into  two  main  classes,  personal  powers  in- 
herent in  the  individual,  and  material  things.  If  an  in- 
dividual does  not  have  some  form  and  degree  of  ownership 
in  the  former  he  is  a  slave,  the  property  of  some  outside 
party,  and  outside  the  system  altogether.  The  modern 
world  is,  of  course,  pretty  well  committed  to  private  prop- 
erty in  the  individual's  own  personal  powers  in  all  adults 
not  dangerously  abnormal  or  incompetent,  subject  only  to 
general  limitations.  It  is  difficult  to  secure  effective  utiliza- 
tion of  these  under  any  other  system,  and  the  live  questions 
relate  only  to  the  ownership  of  material  things.1  We  have 
seen  in  different  connections  that  the  importance  of  the 
difference  between  these  two  classes  is  at  least  much  ex- 
aggerated, that  generic  natural  differences  are  hard  if  not 
impossible  to  find  in  relation  either  to  their  cause-and- 
effect  bearings  on  price  theory  and  economic  organization 
or  to  their  moral  standing.  The  conditions  of  demand, 
conditions  of  supply,  and  relation  to  the  possessing  individ- 
ual turn  out  on  examination  to  be  much  alike,  and  differ- 
ences which  exist  at  all  are  mostly  artificial  and  conven- 
tional. But  from  the  standpoint  of  our  human  interests 
outside  the  production  and  consumption  of  goods  we  must 

1  We  make  no  distinction  between  natural  agents  and  produced  equip- 
ment goods,  as  we  have  shown  that  under  competition  no  final  distinction 
can  be  drawn  between  preemption  and  production.  (See  the  discussion  of 
land  and  capital  in  chapters  iv,  v,  and  xi.)  In  this  connection  we  may 
remark  here  that  we  are  not  necessarily  in  disagreement  with  a  separation 
of  land  from  capital  from  the  point  of  view  taken  by  Marshall  (Principles 
of  Economics,  book  iv,  chap.  i).  From  the  standpoint  of  a  single  political 
unit  occupying  a  limited  area  of  the  earth  whose  natural  resources  are 
thoroughly  explored,  they  stand  in  a  different  relation  as  to  new  supply 
from  that  which  they  occupy  in  a  world  economy  or  a  vast  and  relatively 
new  country  like  the  United  States. 


SOCIAL  ASPECTS  355 

recognize  that  the  ownership  of  one's  self  is  in  a  somewhat 
higher  position  than  the  ownership  of  external  objects. 
Yet  in  a  civilization  where  man  is  highly  and  increasingly 
dependent  on  access  to  and  use  of  material  things  for  his 
very  life  this  distinction  tends  to  fade  out,  and  recognition 
of  this  fact  accounts  for  much  of  the  current  ferment  and 
change  in  the  social  attitude  toward  "property"  (used 
narrowly  as  property  in  things). 

Another  line  of  argument  on  the  question  of  the  relations 
between  ownership  of  one's  own  powers  and  ownership  of 
material  things  follows  somewhat  parallel  lines  to  a  some- 
what similar  uncertain  or  negative  conclusion,  beginning 
from  an  opposed  point  of  view.  The  starting-point  of  our 
inquiry  is  the  fact,  clearly  brought  out  by  our  study  of 
enterprise,  that  the  drift  under  non-interference  is  toward 
placing  the  control  of  industry,  the  ultimate  entrepreneur- 
ship,  in  the  hands  of  property-owners  and  not  the  owners 
of  the  human  services,  the  workers.  The  ostensible  reason 
for  this  is  that  a  business  venture  offers  opportunity  for 
actual  absolute  loss,  as  well  as  merely  a  greater  or  less  gain, 
and  that  only  property  can  in  the  nature  of  the  case  make 
the  guarantees  against  this  net  loss.  This  fact  seems  at 
first  sight  to  afford  the  basis  for  another  distinction  be- 
tween labor  and  property  services,  namely,  that  laborers 
are  only  used  in  industry,  while  material  goods  are  used  up, 
that  only  the  services  are  consumed  in  the  one  case,  while 
the  thing  itself  may  be  destroyed  in  the  other. 

A  little  critical  reflection  will  show  that  this  also  is  not 
really  the  case.  Perhaps  it  ought  to  be  so,  but  it  is  not,  and 
cannot  be.  In  the  first  place,  the  risk  of  destruction  and  to- 
tal loss  is  perhaps  as  great  in  fact  in  the  case  of  the  laborer 
as  in  the  case  of  the  property-owner,  and  where  in  the  latter 
case  the  owner  loses  only  productive  power  the  former 
loses  health  or  bodily  members  or  his  life,  which  mean 
vastly  more.  The  real  merits  of  this  situation  are  also  being 
recognized  by  society  and  we  see  the  growth  of  legislation 


356  RISK,  UNCERTAINTY,  AND  PROFIT 

designed  to  transfer  the  hazard  of  loss  of  the  economic 
value  of  the  laborer  as  a  productive  agent  (and  this  only,  so 
far)  to  the  business  and  through  it  to  the  consumer  of  the 
product.  There  is  another  side  to  the  question  in  the  haz- 
ard of  loss  of  specialized  skill  and  training.  These  are  ac- 
quired in  connection  with  and  for  use  in  the  particular 
business.  The  cost  of  acquisition  is  borne  chiefly  by  the 
worker  and  if  the  business  proves  unprofitable,  the  loss 
generally  falls  on  him.  Yet  these  "risks,"  seemingly  so 
much  greater  than  those  incurred  by  the  property-owner, 
do  not  carry  with  them  the  control  of  the  business,  nor  do 
the  bearers  of  the  risks  even  secure  under  competitive  free 
contract  (as  is  perfectly  well  known)  anything  like  fair  com- 
pensation in  the  form  of  a  higher  contractual  return.  And 
it  must  be  added  that  the  actuarial  value  of  the  worker's 
risks  depends  quite  as  much  on  the  quality  of  the  manage- 
ment as  is  the  case  with  those  of  the  owner  of  material 
property. 

The  only  visible  explanation  of  this  state  of  things  is  an 
appeal  to  a  "fact  of  human  psychology"  that  the  owners 
of  "things"  are  less  willing  to  trust  those  "things"  to  the 
control  of  others  without  an  adequate  guarantee  in  kind 
than  are  men  who  own  only  themselves  to  hazard  such 
outside  control  without  even  the  poor  safeguard  of  a 
guarantee  against  economic  loss.1 

It  is  manifestly  impossible  to  carry  on  production  with- 
out incurring  both  sorts  of  uncertainties,  uncertainty  as 
to  the  results  and  as  to  the  preservation  intact  of  the  means 
of  production  employed,  both  human  and  material.  Since 
production  must  precede  consumption  and  requires  time, 
all  those  concerned  in  it  must  be  maintained  during  the 
production  period  out  of  the  fruits  of  previous  production. 
And  these  products  must  be  advanced  by  those  who  own 

1  It  is  interesting  to  observe  the  concern  of  the  management  for  the 
personal  security  of  the  workers  brought  about  by  compensation  laws, 
and  especially  the  remarkable  results  of  the  "safety  first"  movement  in 
reducing  accidents. 


SOCIAL  ASPECTS  357 

them.  It  is  not  physically  necessary  that  they  be  per- 
manently hazarded  by  the  owners,  that  the  actual  pro- 
ducers should  get  their  entire  wage  in  advance  of  the  com- 
pletion of  the  process,  but  this  is  the  way  it  works  out 
under  free  contract.  Nor  is  it  inevitable  that  these  products 
be  owned  by  any  individuals  at  all,  a  point  which  we  must 
next  take  up.  At  the  same  time  the  chance  of  loss  of  equip- 
ment must  be  borne,  temporarily,  by  those  who  have 
equipment  to  lose,  if  equipment  is  privately  owned.  The 
permanence  of  the  loss  to  an  individual  owner  is  not 
physically  prescribed,  in  case  of  the  owner  of  material 
things  or  of  human  powers  in  their  purely  economic  aspect. 
But  this  again  is  the  way  it  does  work  out  under  the  "ob- 
vious and  simple  system  of  natural  free  contract."  We 
must  now  glance  briefly  at  the  social  bearings  of  free  con- 
tract in  a  more  fundamental  sense. 

There  is  naturally  no  intention  of  implying  that  freedom 
of  contract  is  to  any  appreciable  extent  a  result  of  the  de- 
liberate adoption  by  society  of  a  reasoned  policy  of  organ- 
ization. However,  the  continuation  of  the  system  is  a 
question  which  has  been  much  discussed  on  its  merits  and 
which  may  ultimately  be  decided  on  the  basis  of  discussion. 
To  discuss  the  issue  systematically  we  shall  first  eliminate 
and  postpone  for  later  notice  the  point  as  to  personal  self- 
ownership  and  limit  ourselves  provisionally  to  the  owner- 
ship of  material  productive  goods,  the  more  or  less  live 
issue  between  individual  and  social  property  in  these  things. 
And  we  must  further  distinguish  at  the  outset  between  two 
different  and  to  a  large  extent  opposed  sets  of  interests 
involved  in  social  organization.  The  conventional  view 
in  economics  treats  social  organization  as  a  mechanism  for 
the  satisfaction  of  "wants"  which  are  assumed  to  be  fixed 
conscious  desires  and  tendencies  to  action,  subject  to  the 
principle  of  diminishing  relative  utility.  The  limitations  of 
this  view  have  been  emphasized  throughout  our  study,  but 
we  have  to  consider  this  aspect  of  economic  life  in  purity 


358  RISK,  UNCERTAINTY,  AND  PROFIT 

and  isolation  if  we  are  to  use  the  scientific  method  of 
analysis.  Other  interests  are  just  as  fundamental,  notably 
the  desire  for  freedom  and  power  for  their  own  sakes  and 
the  preference  for  certain  qualities  of  human  relations.  It 
is  largely  this  second  set  of  interests  which,  directly  and  in- 
directly, have  finally  abolished  slavery  and  established  self- 
ownership. 

Viewing  society,  then,  as  a  want-satisfying  machine  and 
applying  the  single  test  of  efficiency,  free  enterprise  must 
be  justified  if  at  all  on  the  ground  that  men  make  decisions, 
exercise  control,  more  effectively  if  they  are  made  respon- 
sible for  the  results  of  the  correctness,  or  the  opposite,  of 
those  decisions.  If  property  were  socialized  we  should  still 
have  to  concentrate  the  function  of  the  actual  making  of 
decisions,  but  it  would  be  in  a  far  greater  degree  than  now 
a  routine  task,  with  the  remuneration  independent  of  the 
results.  In  the  light  of  our  previous  discussion  there  is  a 
difficulty  here  and  we  must  be  careful  to  make  the  meaning 
clear.  Two  things,  specifically,  would  happen.  Businesses 
in  which  men  now  work  directly  with  their  own  resources 
would  be  transformed  into  public  enterprises  under  the 
management  of  hired  functionaries.  In  this  case  the  nature 
of  the  change  is  clear  enough.  More  obscure  is  the  case  of 
the  corporation,  now  controlled  by  a  hired  manager.  Here 
the  change  is  the  substitution  of  the  public,  organized  in 
some  political  way,  for  the  stockholders,  and  the  position 
of  the  immediate  decision-maker  is  superficially  not  much 
changed. 

But  only  superficially.  It  is  true  that  the  growing  simi- 
larity of  large-scale  business  to  the  political  democracy  is 
one  of  the  socialist's  strongest  arguments  against  a  prob- 
able loss  of  efficiency  in  the  exchange  of  private  for  public 
ownership.  But  we  must  emphasize  the  fact  that  the  simi- 
larity is  much  exaggerated  —  in  fact  by  both  parties  to 
the  controversy,  from  different  motives,  of  course.  The 
insistence  on  the  large  number  of  stockholders  in  some  of 


SOCIAL  ASPECTS  359 

our  great  corporations  is  definitely  misleading.  Most  of 
these  do  not  regard  themselves  and  are  not  regarded  as 
owners  of  the  business.  In  form  they  are  such,  but  in  sub- 
stance they  are  merely  creditors,  and  both  they  and  the 
insiders  count  upon  the  fact.  The  great  companies  are 
really  owned  and  managed  by  small  groups  of  men  who 
generally  know  each  other's  personalities,  motives,  and 
policies  tolerably  well.  Hence  in  the  first  place  the  salaried 
manager  under  a  socialist  government,  whether  appointed 
by  a  political  superior  or  chosen  in  some  way  by  a  democra- 
tic constituency,  would  really  be  in  a  very  different  position 
from  the  president  or  manager  of  a  present-day  corpora- 
tion. He  could  not  conceivably  be  so  directly  accountable 
to  the  ultimate  entrepreneur,  society,  as  he  now  is  to  the 
ultimate  entrepreneur,  the  small  group  of  "insiders"  who 
are  the  real  owners  of  the  business. 

But  the  greater  change  would  consist  in  the  substitution 
of  the  public  at  large  for  the  small  group  of  owners.  The 
main  difference  is  an  inevitable  concomitant  of  the  mere 
size  of  a  group.  The  insuperable  difficulty  of  cooperative 
production  has  been  to  make  the  individual  feel  that  the 
results  depend  upon  his  own  activity.  The  individual  feels 
lost  in  the  mass,  helpless  and  insignificant.  Political  dem- 
ocracy, of  course,  encounters  the  same  difficulty.  Perhaps 
we  may  believe  that  some  progress  is  being  made  in  solving 
the  problem  in  the  political  sphere  where  decisions  are 
really  much  less  important  in  that  the  alternatives  among 
which  choice  is  made  relate  to  less  vital  matters.  If  so,  it 
may  be  possible  that  some  generations  of  political  democ- 
racy might  train  the  individual  in  a  sense  of  personal  re- 
sponsibility which  would  make  industrial  democracy  more 
feasible. 

But  this  is  at  best  an  exceedingly  superficial  view  of  the 
problem.  At  bottom  it  is  a  matter  of  feeling  for  the  large 
property-owner  as  well  as  for  the  masses  served  by  in- 
dustry.   He  is  really  a  social  functionary  now.    Private 


360  RISK,  UNCERTAINTY,  AND  PROFIT 

property  is  a  social  institution;  society  has  the  unquestion- 
able right  to  change  or  abolish  it  at  will,  and  will  maintain 
the  institution  only  so  long  as  property-owners  serve  the 
social  interest  better  than  some  other  form  of  social  agency 
promises  to  do.  Of  course  there  is  a  lot  of  moral  flub-dub 
about  natural  rights,  sacred  institutions  of  the  past,  etc., 
and  it  has  some  power  to  hold  back  social  change.  But  in 
the  end,  and  a  not  very  distant  end  either,  the  question  will 
be  decided  on  the  basis  of  what  the  majority  of  the  people 
think,  in  a  more  or  less  cold-blooded  way,  about  the  issues. 
If  we  get  more  effective  management  through  the  system  of 
concentrated  private  ownership  than  we  would  through 
some  democratic  machinery,  it  is  because  men  plan  better 
when  they  do  not  feel  like  government  officials  doing  things 
for  other  people,  when  they  feel  their  work  as  their  own  and 
identify  their  personalities  with  it. 

And  this  even  though  the  same  men  know  "in  their 
hearts,"  subconsciously  if  not  consciously,  that  they  are 
the  agents  of  the  democracy  and  ultimately  responsible 
to  it  for  their  trust.  For  it  is  clear  that  the  "personal" 
interests  which  our  rich  and  powerful  business  men  work 
so  hard  to  promote  are  not  personal  interests  at  all  in  the 
conventional  economic  sense  of  a  desire  to  consume  com- 
modities. They  consume  in  order  to  produce  rather  than 
produce  in  order  to  consume,  in  so  far  as  they  do  either. 
The  real  motive  is  the  desire  to  excel,  to  win  at  a  game, 
the  biggest  and  most  fascinating  game  yet  invented,  not 
excepting  even  statecraft  and  war. 

The  suggestion  which  inevitably  comes  to  mind  is  that  a 
democratic  economic  order  might  conceivably  appeal  as 
effectively  to  the  same  fundamental  motives.  What  is 
necessary  is  a  development  of  political  machinery  and  of 
political  intelligence  in  the  democracy  itself  to  a  point 
where  men  in  responsible  positions  would  actually  feel 
their  tenure  secure  and  dependent  only  on  their  success  in 
filling  the  position  well.    It  is  not  mainly  a  matter  of 


SOCIAL  ASPECTS  361 

salary,  though  undoubtedly  such  men  would  have  to  live 
conspicuously  well  in  an  economic  sense  also  —  just  as  the 
officials  of  our  political  democracy  expect  to  do,  even  when 
patriotic  and  public-spirited.  The  essential  problem  is 
wisely  to  select  such  responsible  officials  and  promote  them 
strictly  on  a  basis  of  what  they  accomplish,  to  give  them  a 
"free  hand"  to  make  or  mar  their  own  careers.  This  is 
the  lesson  that  must  be  learned  before  the  democratization 
of  industry  will  become  a  practical  possibility.  If  we  sub- 
stitute for  business  competition,  bad  as  it  is,  the  game 
of  political  demagoguery  as  conventionally  played,  with 
rotation  in  office  and  "to  the  victors  belong  the  spoils"  as 
its  main  principles,  the  consequences  can  only  be  dis- 
astrous. 

Another  interesting  misconception  in  regard  to  the  pub- 
lic official  should  be  pointed  out  before  we  leave  this  topic. 
It  is  common  and  natural  to  assume  that  a  hired  manager, 
dealing  with  resources  which  belong  to  others  will  be  less 
careful  in  their  use  than  an  owner.  The  view  shows  little 
insight  into  human  nature  and  does  not  square  with  ob- 
served facts.  The  real  trouble  with  bureaucracies  is  not 
that  they  are  rash,  but  the  opposite.  When  not  actually 
rotten  with  dishonesty  and  corruption  they  universally 
show  a  tendency  to  "play  safe"  and  become  hopelessly 
conservative.  The  great  danger  to  be  feared  from  a  political 
control  of  economic  life  under  ordinary  conditions  is  not  a 
reckless  dissipation  of  the  social  resources  so  much  as  the 
arrest  of  progress  and  the  vegetation  of  life. 

This  point  leads  naturally  to  the  question  which  has 
been  much  discussed  in  treatments  of  risk  and  profit :  does 
the  private  business  man  really  abhor  risk  and  uncertainty, 
and  tend  also  to  "play  safe"?  Other  phases  of  the  same 
question,  the  close  relations  of  which  are  not  always  recog- 
nized, but  which  turn  out  to  involve  the  same  issue,  relate 
to  the  social  cost  of  risk-taking  and  the  tendency  of  profits 
to  a  minimum. 


362  RISK,  UNCERTAINTY,  AND  PROFIT 

The  conventional  view  is,  of  course,  to  regard  risk-taking 
as  repugnant  and  irksome  and  to  treat  profit  as  the  "re- 
ward" of  assuming  the  "burden."  This  is,  of  course,  the 
business  man's  own  idea  of  the  matter,1  and  students  of 
the  problem  have  often  held  the  same  opinion.  Thus 
Willett 2  argues  that  society  pays  for  the  sacrifice  of  as- 
suming risk  through  higher  prices  for  commodities  in  whose 
production  it  is  a  factor,  for  the  reason  that  men  are  deterred 
from  entering  these  occupations  by  their  unwillingness  to 
assume  risk  and  that  the  supply  of  such  commodities  is 
consequently  reduced.  Ross  also  assumes  3  that  risk  is 
repugnant  and  draws  the  same  conclusion,  and  Haynes  4 
lays  still  greater  emphasis  on  the  influence  of  risk  as  a 
deterrent  to  production,  quoting  Andrews  5  to  the  same 
effect.  Other  writers  have  been  more  hesitant  in  general- 
izing or  have  made  distinctions,  or  positively  disagreed 
with  this  view.  Thus  v.  Mangoldt 6  remarks  that  it  is 
notorious  that  more  money  is  lost  than  made  in  most  forms 
of  speculative  activity  and  asserts  the  belief  that  this  is 
true  of  business  enterprise  in  communities  which  are  in 
comfortable  circumstances  and  have  a  reasonable  surplus 
for  embarking  in  venturesome  undertakings.  Professor 
F.  M.  Taylor  also  analyzes  the  problem  with  some  care,7 
insisting  that  the  profits  of  entrepreneurs  may  be  either 
larger  or  smaller  than  the  amount  necessary  to  make  up 
an  insurance  fund  to  cover  actual  losses.  He  holds  it  prob- 
able that  they  are  for  small  risks  larger  and  for  large  risks 
much  smaller  than  the  necessary  insurance  fund,  but  con- 

1  See  Merril,  J.  C.  R,  article  on  "Speculation,"  Price  Current  Grain 
Reporter,  September  29,  1915,  pp.  26-27:  "It  is  a  universal  axiom  of 
business  that  the  greater  the  risk  involved  in  any  line  of  business  the 
greater  must  be  the  profits  to  those  engaged  in  it,  or  .  .  .  profits  are  in 
proportion  to  risks!" 

2  Economic  Theory  of  Risk  and  Insurance,  pp.  55-56. 
8  Op.  cit.  (Annals,  Am.  Acad.,  1896),  p.  119. 

4  Quarterly  Journal  of  Economics,  vol.  ix,  no.  4,  p.  414. 

5  Institutes  of  Economics,  p.  54.  6  Unternehmergeivinn,  p.  85. 
7  Principles  of  Economics  (1913),  pp.  366-67,  383-84. 


SOCIAL  ASPECTS  363 

eludes  that  society  has  to  pay  a  higher  price  for  a  particu- 
lar commodity  or  service  than  it  would  have  to  pay  if 
risk  were  eliminated. 

There  are  several  confusions  of  thought  to  be  avoided  in 
arguing  this  question.  In  the  first  place  it  is  inaccurate  to 
speak  of  profit  as  the  reward  of  risk-taking  or  as  the  in- 
ducement to  take  risk.  It  is  of  the  essence  of  the  situa- 
tion that  the  profit  is  in  the  future  and  uncertain  when  the 
decision  is  made  and  hence  it  is  the  prospect  or  estimated 
probability  x  of  profit  which  "moves  men's  wills"  (Taylor). 
Hence  we  cannot  assert  a  connection  between  actual  profit 
and  the  irksomeness  of  risk  in  the  individual  instance.  And 
from  the  standpoint  of  aggregate  profit  in  the  society  as  a 
whole  the  question  is  whether  there  is  any  such  share  or 
not,  whether  entrepreneurs  as  a  class  make  a  profit  or  suffer 
a  loss  (speaking,  of  course,  of  net  or  "pure"  profit,  after 
remunerations  for  all  productive  services  are  counted  out). 

Let  us  recall  for  clearness  the  precise  situation  of  the 
profit-seeking  business  man.  He  contracts  for  productive 
services  in  advance,  on  a  basis  of  what  he  expects  to  be  able 
to  make  by  their  use.  Like  the  purchaser  of  any  commodity, 
he  as  an  individual  finds  a  price  fixed  and  buys  more  or 
less  at  the  established  price,  while  in  the  aggregate  the  com- 
petition of  all  purchasers  adjusts  the  price  to  the  point 
where  an  entire  existing  supply  can  just  be  taken  out  of 
the  market.  It  will  be  seen  that  the  prices  of  productive 
services  at  any  time,  the  entrepreneurs'  costs  of  production, 
represent  under  perfect  competition  what  entrepreneurs 
expect  their  products  to  be  worth  when  sold,  while  the  en- 
trepreneurs' incomes  represent  the  facts  at  a  later  time  as 
contrasted  with  the  anticipations  at  an  earlier.  The  con- 
dition, then,  under  which  entrepreneurs  as  a  group  will 
realize  a  positive  profit  is  that  they  underestimate  the  pros- 

1  J.  S.  Mill  stated  that  chances  of  profit  tend  to  equality,  but  in  the 
fifth  edition  changed  the  word  "chances"  to  "expectations."  See 
Principles,  Ashly  edition,  p.  412. 


364  RISK,  UNCERTAINTY,  AND  PROFIT 

pects  of  their  business  relatively  to  their  dispositions  to 
venture.  If,  on  the  contrary,  they  overestimate  their  pros- 
pects (considering  the  degree  of  conviction  necessary  to 
move  their  wills),  they  will  in  the  aggregate  suffer  loss, 
and  if  they  estimate  correctly  on  the  whole,  neither  will 
occur.  If  the  estimates  are  a  matter  of  pure  chance  it 
WOllld  seem  that  the  variations  in  the  two  directions  would 
be  equal,  the  average  correct,  and  the  general  level  of  pure 
profit  zero.  Many  writers,  notably  Hawley,1  have  assumed 
that  such  a  distribution  of  errors  necessarily  obtains,  though 
in  the  absence  of  a  correct  theory  of  profit  the  appropriate 
conclusion  is  not  drawn.2 

It  may  be  objected  that  it  is  impossible  that  enterprise 
on  the  whole  should  suffer  a  net  loss,  but  a  little  considera- 
tion will  show  that  this  is  not  true.  The  entrepreneur,  as 
society  is  organized,  is  almost  always  a  property-owner  and 
must  necessarily  be  the  owner  of  productive  power  in  some 
form.  It  may  then  well  be  that  entrepreneurs  lose  more 
than  they  make,  the  difference  coming  out  of  the  returns 
due  them  in  some  capacity  other  than  that  of  entrepreneur. 
The  question  of  fact  is  thus  whether  entrepreneurs  as  a 
class  receive  on  the  average  more  or  less  than  the  normal 
competitive  rate  of  return  on  the  productive  services  of 
person  or  property  which  they  furnish  to  business. 

The  question  does  not  admit  of  any  definitive  answer  on 
inductive  grounds.  Such  evidence  as  is  avaliable  in  the  form 
of  statistics  points  to  the  conclusion  that  the  net  result  is  a 
loss,  but  it  is  inconclusive.3  Perhaps  the  best  that  can  be 

1  See  above,  chapter  n,  p.  42. 

2  Hawley  sometimes  holds  that  profit  is  negative  (Quarterly  Journal  of 
Economics,  vol.  xv,  p.  609)  and  at  other  times  that  it  is  positive.  (Ibid., 
P.  79.) 

8  M.  Porte,  Entrepreneurs  et  profits  industriels  (Paris,  1905),  argues  to 
this  conclusion  from  certain  figures  on  business  failures  in  Massachusetts. 
The  results  of  studies  of  farm  accounts  by  the  New  York  State  College  of 
Agriculture  indicate  that  farmers  commonly  make  less  than  fair  wages 
and  a  fair  return  on  the  investment,  and  investigations  of  public  utility 
ventures  have  yielded  similar  results.  The  best  study  of  the  distribution 


SOCIAL  ASPECTS  365 

done  is  to  argue  the  case  on  a  priori  grounds  and  attempt 
nothing  beyond  an  opinion  as  to  the  probable  facts.  The 
writer  is  strongly  of  the  opinion  that  business  as  a  whole 
suffers  a  loss.  The  main  facts  in  the  psychology  of  the  case 
are  familiar,  and  some  of  them  have  been  stated  above. 
The  behavior  of  men  in  lotteries  and  gambling  games  is 
the  most  striking  fact.  Adam  Smith  pointed  out  the  tend- 
ency of  human  nature  to  exaggerate  the  value  of  a  small 
chance  of  large  winnings.  Senior  1  thought  that  the  im- 
agination exaggerates  the  large  odds  in  favor  of  either 
gains  or  losses.  Cannan  2  holds  that  both  unusually  risky 
and  unusually  safe  investments  are  especially  attractive  to 
large  classes  of  men  and  yield  too  small  a  return  while  or- 
dinary hazards  are  neglected  and  hence  yield  more.  Pro- 
fessor Carver  contributes  the  suggestion3  that  business 
risks  are  predominantly  of  the  character  in  which  the  odds 
are  not  great  and  the  possible  losses  larger  than  the  prob- 
able gains,  that  these  have  a  negative  appeal  to  the  gam- 
bling instinct  and  that  profit  is  a  positive  quantity.  But  in 
view  of  the  possibility  of  capitalizing  the  entire  future  re- 
turn of  a  venture  into  present  wealth  this  view  of  the  na- 
ture of  business  risks  seems  very  questionable.  The  point 
we  wish  to  emphasize  is  that  these  "risks"  do  not  relate  to 
objective  external  probabilities,  but  to  the  value  of  the 

of  income  in  the  United  States,  by  Dr.  W.  I.  King,  reaches  the  conclusion 
that  the  average  profit  per  entrepreneur  in  this  country  is  about  one  and 
four  tenths  times  the  average  wage  per  laborer.  (See  Wealth  and  Income 
of  the  People  of  the  United  States,  p.  165.)  It  seems  safe  to  assume  that 
entrepreneurs  have  greater  ability  than  laborers  in  a  larger  ratio  than 
this,  especially  since  a  large  proportion  of  the  wage-earners  reported  by 
the  Census  are  women  and  young  persons  and  children.  But  Dr.  King's 
division  of  income  into  shares  and  his  estimates  of  the  numbers  of  re- 
cipients of  each  type  are  both  replete  with  long-range  deductions  and  as- 
sumptions leaving  so  much  room  for  error  that  little  if  any  confidence  can 
be  placed  in  the  result. 

1  Cited  by  Cannan,  History  of  Theories  of  Production  and  Distribution, 
p.  369. 

2  Article  on  "Profit"  in  Palgrave's  Dictionary  of  Political  Economy. 

3  Distribution  of  Wealth,  p.  283. 


I 


366  RISK,  UNCERTAINTY,  AND  PROFIT 

judgment  and  executive  powers  of  the  person  taking  the 
chance.  It  is  certainly  true  that  as  Smith  and  v.  Mangoldt 
both  observed,  most  men  have  an  irrationally  high  confi- 
dence in  their  own  good  fortune,  and  that  this  is  doubly 
true  when  their  personal  prowess  comes  into  the  reckoning, 
when  they  are  betting  on  themselves.  Moreover,  there  is 
little  doubt  that  business  men  represent  mainly  the  class  of 
men  of  whom  these  things  are  most  strikingly  true;  they 
are  not  the  critical  and  hesitant  individuals,  but  rather 
those  with  restless  energy,  buoyant  optimism,  and  large 
faith  in  things  generally  and  themselves  in  particular. 

To  these  considerations  must  be  added  the  stimulus  of 
the  competitive  situation,  constantly  exerting  pressure  to 
outbid  one's  rivals,  as  in  an  auction  sale,  where  things  often 
bring  more  than  any  one  thinks  they  are  worth.  Another 
large  factor  is  the  human  trait  of  tenacity,  also  conspicuous 
in  bourgeois  psychology.  Men  may  possibly  be  timid  and 
critical  on  first  embarking  in  new  ventures,  but  once  com- 
mitted, it  seems  unquestionable  that  the  general  rule  is  to 
hold  on  to  the  last  ditch,  and  the  greater  part  of  the 
bidders  for  productive  services  are  owners  of  businesses  al- 
ready established.  The  prestige  of  entrepreneurship  and 
the  satisfaction  of  being  one's  own  boss  must  also  be  con- 
sidered. It  therefore  seems  most  reasonable  to  suppose  that 
the  prices  of  these  are  fixed  at  a  level  above  rather  than 
below  that  which  the  facts  actually  warrant,  and  as  we 
have  noticed,  the  statistics,  such  as  they  are,  point  to  the 
same  conclusion. 

So  much  for  the  pure  profit  of  entrepreneurs.  We  have 
already  emphasized  the  fact  that  profit  and  imputed  in- 
come are  never  accurately  separated  on  either  side  of  the 
dividing  line.  As  there  is  no  income  which  is  pure  profit  so 
there  is  none  which  does  not  contain  an  element  of  profit. 
This  is  perhaps  most  conspicuous,  or  at  least  most  familiar, 
in  connection  with  interest.  It  is  recognized  that  "pure  in- 
terest "  is  impossible  of  identification,  that  ordinary  inter- 


SOCIAL  ASPECTS  367 

est  includes  an  element  of  "risk  premium."  It  is  no  less 
true  that  wages  contain  a  variable  element  which  is  to  be 
explained  by  the  uncertainty  of  the  return.  The  earnings 
of  professional  men  form  the  notorious  case.  Men  are 
attracted  into  these  callings  more  by  the  lure  of  the  small 
chance  of  conspicuous  success  than  by  the  position  achieved 
by  the  rank  and  file.  Adam  Smith  was  sure,  and  the  opin- 
ion is  still  corroborated  by  common  observation,  that  an 
occupation  offering  a  small  chance  of  attaining  a  high 
position  and  a  large  income  will  yield  a  lower  average  re- 
turn to  the  same  ability  than  one  in  which  earnings  are 
more  uniform.  That  is,  there  is  a  negative  premium  on 
risk-taking  in  these  cases  also. 

With  most  kinds  of  labor  the  chance  element  amounts  to 
relatively  little  in  all  probability,  and  in  any  case  it  is  per- 
haps best  regarded  as  a  return  on  the  investment  in  special 
knowledge  and  skill  rather  than  on  effort  directly.  In  any 
case,  if  Smith's  reasoning  is  sound  it  appears  that  risk- 
taking  is  the  opposite  of  irksome,  that  men  work  (or  labor 
to  acquire  the  capacity  for  work)  more  cheaply  on  the 
average  for  an  uncertain  than  for  a  fixed  compensation. 
To  the  landowner  there  is  virtually  no  risk  of  actual  loss 
involved  in  leasing  it,  and  usually  little  or  none  of  failure  to 
receive  the  contract  rental.  In  lending  capital  we  find  risk 
of  loss  of  principal  as  well  as  interest  and  a  great  deal  of 
attention  is  paid  to  the  risk  element  in  fixing  the  rate  of 
return.  A  rate  of  pure  interest  is  a  concept  to  which  it  is  so 
difficult  to  attach  any  definite  meaning  that  it  seems  futile 
to  speculate  as  to  the  adequacy  of  the  excess  of  contract 
interest  above  this  level  to  constitute  an  insurance  fund  to 
cover  losses.  The  question,  as  before,  is  whether  the  actual 
receipts  from  contract  interest  and  repayments  of  principal 
form  on  the  average  an  amount  equal  to  or  less  or  more  than 
the  pure  interest  and  the  original  principal.  The  writer 
sees  no  way  of  forming  an  opinion  on  this  subject. 

From  the  standpoint  of  social  policy,  two  questions  are 


368  RISK,  UNCERTAINTY,  AND  PROFIT 

to  be  raised.  From  one  point  of  view,  "society"  is  a  hus- 
bandman or  "  vrirtschaf  tender  Mensch"  interested  in  getting 
its  work  done  as  well  and  as  cheaply  as  possible.  The  fore- 
going considerations  seem  to  indicate  that  from  this  pure 
productive  efficiency  point  of  view  and  with  all  the  factors 
measured  in  competitive  pecuniary  terms  it  is  better  to  let 
the  individual  "take  the  risk.  It  seems  probable  that  with 
society  and  human  nature  as  they  are,  the  individual  not 
only  charges  nothing  for  this  service,  but  pays  something 
for  the  privilege  of  rendering  it  —  on  the  average.  But  we 
must  remember  that  in  the  case  of  property  he  really  does 
not  take  the  risk,  and  it  is  a  question  of  making  him  feel  that 
he  does,  for  property  is  and  always  has  been  "really"  social 
and  ownership  a  social  function.  It  is  not  clear  that  the 
illusion  of  ownership,  with  the  possibility  and  actuality  of 
enormous  waste  and  dissipation  involved,  is  in  fact  a  cheap 
way  for  society  to  remunerate  the  management  of  its  mate- 
rial wealth.  As  with  all  questions  involving  human  motives, 
however,  only  negative  statements  can  be  made  on  this 
subject  until  we  begin  to  know  something  of  what  men  as 
individuals  and  as  society  really  want.  The  quality  of 
management  secured  has,  of  course,  to  be  taken  into  ac- 
count along  with  the  cost  of  securing  it,  but  we  have  al- 
ready said  all  that  it  seems  worth  while  to  say  in  the  present 
connection  on  this  head. 

The  second  question  raised  is  whether  it  is  really  good 
for  the  individual,  and  hence  for  society  which  is  the  in- 
dividual in  the  aggregate,  to  have  the  risks  of  industry  as- 
sumed by  the  former  even  if  he  is  willing  to  do  it  at  a  loss, 
on  the  average,  to  himself.  Some  light  on  the  proper  an- 
swer is  to  be  gained  by  considering  the  attitude  which  we 
actually  take  toward  lotteries  and  gambling  generally. 
Clearly  there  are  limits  to  the  terms  on  which  the  members 
of  society  are  to  be  allowed  to  take  chances,  and  notably 
when  the  independent  members  have  dependent  upon  them 
other  members  in  whom  society  is  peculiarly  interested. 


SOCIAL  ASPECTS  369 

Rapid  progress  is  at  present  being  made  toward  prohibiting 
the  laborer  from  unwisely  contracting  to  assume  hazards, 
and  no  theoretical  objection  can  be  made  to  extending  the 
principle  to  property  risks  where  the  fundamentals  of  a 
decent  and  self-respecting  existence  are  at  stake. 

The  protection  of  a  minimum  standard  of  life  is  only  one 
of  many  questions  of  the  human  interests  involved  in  the 
distribution  of  risk  and  control,  but  we  cannot  here  go  into 
or  even  attempt  to  classify  or  enumerate  a  list.  In  conclud- 
ing the  discussion  of  the  topic  we  shall  only  insist  again  on 
the  limitations  of  the  economic  view  of  social  organization 
as  a  mechanism  for  satisfying  human  wants  in  any  static 
and  hence  scientifically  describable  sense  of  the  term. 
Man's  chief  interest  in  life  is  after  all  to  find  life  interesting, 
which  is  a  very  different  thing  from  merely  consuming  a 
maximum  amount  of  wealth.  Change,  novelty,  and  sur- 
prise must  be  given  large  consideration  as  values  per  se, 
and  since  at  best  most  of  us  must  doubtless  spend  more 
time  in  producing  wealth  than  in  consuming  it,  the  dy- 
namic and  personal  factors  must  be  taken  into  account  on 
the  production  side  of  economic  conduct,  and  weighed 
against  the  element  of  efficiency.  One  of  the  things  we 
surely  want  is  the  society  of  other  people  on  a  basis  of 
mutual  agreeability,  respect,  and  affection,  irrespective  of 
the  question,  itself  inescapable  in  any  serious  reflection  on 
the  issues  of  life,  as  to  whether  personality  has  some  sort 
of  cosmic  value.  Hence  each  individual  must  be  given 
responsibility,  freedom  of  choice,  a  wider  sphere  of  self- 
expression  than  he  can  have  in  a  system  of  organization 
where  control  is  specialized  and  concentrated  to  the  last 
degree.  Whether  this  is  practicable  and  how  it  is  to  be  done 
is  the  great  problem  which  confronts  the  advocates  of  in- 
dustrial democracy. 

To  conclude  our  study  notice  must  be  taken  of  certain 
long-time  aspects  of  the  problem  of  uncertainty  and  con- 
trol.  The  distinction  between  "static"  and  "dynamic" 


370  RISK,  UNCERTAINTY,  AND  PROFIT 

"risks"  is  a  much-labored  but  a  fundamental  point  in 
connection  with  our  subject.  We  have  emphasized  in  this 
study  also  that  uncertainty  is  dependent  upon  change,  and 
in  fact  largely  upon  progressive  change.  The  problem  of 
management  or  control,  being  a  correlate  or  implication  of 
uncertainty,  is  in  correspondingly  large  measure  the  prob- 
lem of  progress.  In  an  unprogressive  society  knowledge  of 
the  future  could  be  perfected  to  a  high  degree  through  ac- 
tual forecast  and  control  or  the  effect  of  certainty  secured 
through  the  grouping  of  cases  and  application  of  prob- 
ability reasoning.  Under  such  conditions  the  problem  of 
management  would  be  indefinitely  simplified  as  activity 
would  follow  in  the  main  an  established  routine  and  real 
decisions  would  rarely  be  required.  The  actual  form  of 
economic  control,  free  contract,  and  especially  private 
property  in  material  goods,  is  closely  connected  with  the 
acute  form  of  the  problem  of  management  which  arises 
from  the  highly  "dynamic"  character  of  the  society  we  live 
in  and  the  extreme  degree  of  uncertainty  connected  with 
change.  Before  the  modern  industrial  era  began,  as  we 
know,  the  economic  life  of  Europe  was  unprogressive,  and 
its  organization  of  control  was  collectivistic.  The  establish- 
ment of  individualism  was  the  result  of  the  desire  for 
improvement,  even  though  it  would  be  misleading  to  say 
that  it  came  about  directly  through  a  social  conviction  of 
its  superiority  over  collectivism  in  this  respect. 

The  social  theory  of  private  property  rests,  then,  not  so 
much  on  the  premise  that  productive  resources  will  be 
more  effectively  used  in  the  creation  of  goods  for  consump- 
tion, as  on  the  belief  that  there  will  be  a  greater  stimulus 
to  progress  through  inducing  men  to  take  the  risks  of  action 
increasing  the  supplies  of  productive  resources  themselves, 
including  both  material  things  and  technical  knowledge 
and  skill.  We  have  shown  in  our  discussion  of  interest  the 
fallacy  in  the  view  that  accumulation  and  forward-looking 
sacrifice  can  be  explained  on  the  basis  of  time  preference  in 


SOCIAL  ASPECTS  371 

consumption.  A  sacrifice  of  present  to  future  consumption 
does  not  generally  increase  the  total  consumption  by  the 
individual  making  it,  and  in  addition  the  mere  postpone- 
ment of  consumption  would  give  rise  to  no  considerable 
net  increase  in  social  equipment.  The  "abstinence"  must 
be  permanent,  and  not  a  mere  matter  of  waiting.  It  follows 
that  the  premise  of  the  justification  of  private  property 
must  be  that  the  mere  desire  of  ownership  is  a  more  potent 
motive  to  bring  about  sacrifice  and  effective  control  in  this 
field  than  the  desire  to  consume  a  larger  amount  of  goods. 
The  social  policy  of  private  property  is  sound,  if  at  all, 
because  the  craving  to  own  wealth  will  lead  men  to  sac- 
rifice consumption  and  take  risks  of  complete  loss  in  order 
to  increase  their  property.1  The  truth  or  falsity  of  this 
premise  is  not  our  present  concern,  but  it  seems  worth 
while  to  point  out  some  facts  in  connection  with  its  appli- 
cation. 

Practically  all  forms  of  social  economic  progress  repre- 
sent, as  has  been  pointed  out,  different  modes  of  increasing 
the  productive  power  of  society  through  the  sacrifice  or 
"investment "  of  present  consumption.  These  different 
ways  are  open,  competing  alternatives,  quite  comparable 
generally  speaking  in  quantitative  terms.  One  may  invest 
his  present  goods  in  creating  new  equipment  goods  (the 
conventional  way,  and  type  of  all),  or  in  finding  and  devel- 
oping new  natural  resources,  or  in  developing  his  own  per- 
sonal powers  (or  even  to  some  extent  those  of  other  men), 
or  in  inventing,  or  in  improving  business  organization,  or 
in  creating  new  social  tastes  and  wants.  The  first  two 
modes  of  investment  give  rise  to  new  property  and  this 
society,  generally  speaking,  grants  to  the  successful  in- 
vestor in.  fee  simple  and  to  his  heirs  and  assigns  forever. 

Investment  in  one's  own  person  likewise  gives  rise  to 

1  An  accurate  and  exhaustive  discussion  of  this  point  would  have  to 
distinguish  between  the  motives  of  the  entrepreneur  and  those  of  the 
owner  who  transfers  the  use  of  his  property  to  an  entrepreneur  for  a  fixed 
return. 


372  RISK,  UNCERTAINTY,  AND  PROFIT 

undisputed  possession  of  the  new  capacities,  but  these  are 
not  permanent,  passing  out  of  existence  with  the  end  of  the 
individual's  own  active  life.  It  would  be  interesting,  if  it 
were  possible,  to  compare  the  attractiveness  of  these  two 
forms  of  investment,  for  the  effectiveness  of  control  beyond 
one's  own  lifetime  as  an  incentive  to  investment  is  one  of 
the  principal  issues  in  the  theory  of  enterprise.  We  shall 
recur  to  this  topic  presently. 

The  case  of  investment  in  invention  is  different  again. 
Here,  owing  to  the  low  cost  of  indefinitely  multiplying  an 
idea,  it  is  usually  difficult  to  capitalize  an  increase  in  pro- 
ductive power.  Society  generally  permits  an  inventor  or 
his  assigns  to  keep  his  idea  secret  as  long  as  possible  or 
to  safeguard  it  in  any  manner.  But  this  is  so  commonly 
impracticable  and  the  social  value  of  new  inventions  so 
manifest  that  the  patent  system  has  come  into  general  use 
establishing  and  protecting  by  law  a  temporary,  and  rather 
short-lived,  property  right  in  the  improvement.  It  is  mani- 
fest that  this  is  an  exceedingly  crude  way  of  rewarding  in- 
vention. Not  merely  do  the  consumers  of  the  product  pay, 
which  is  doubtless  fair,  but  large  numbers  of  other  persons 
suffer  who  are  prevented  from  using  the  commodity  by  the 
artificially  high  price.  And  as  the  thing  works  out,  it  is 
undoubtedly  a  very  rare  and  exceptional  case  where  the 
really  deserving  inventor  gets  anything  like  a  fair  reward. 
If  any  one  gains,  it  is  some  purchaser  of  the  invention  or  at 
best  an  inventor  who  adds  a  detail  or  finishing  touch  that 
makes  an  idea  practicable  where  the  real  work  of  pioneering 
and  exploration  has  been  done  by  others.  It  would  seem 
to  be  a  matter  of  political  intelligence  and  administrative 
capacity  to  replace  artificial  monopoly  with  some  direct 
method  of  stimulating  and  rewarding  research. 

The  improvement  of  business  organization  and  methods 
offers  still  less  chance  of  securing  any  permanent  gain, 
since  the  result  is  usually  neither  patentable  nor  capable  of 
being  kept  secret.  Yet  this  form  of  progress  also  represents 


SOCIAL  ASPECTS  373 

an  investment  of  present  wealth  which  could  have  been 
placed  in  fields  yielding  perpetual  property  rights.  Surely 
there  is  no  evidence  of  any  unwillingness  to  make  expendi- 
tures in  this  form  of  improvement,  and  the  fact  raises  in- 
teresting questions  as  to  the  motives  which  actually  oper- 
ate in  inducing  men  to  make  the  present  sacrifices  which 
promote  economic  progress.  Expenditure  in  creating  new 
wants  can  be  made  to  yield  a  more  permanent  advan- 
tage through  the  use  of  distinctive  brands  and  legal  protec- 
tion of  trade  marks  and  trade  names.  Some  of  these,  of 
course,  become  pieces  of  property  of  great  value  and  ready 
salability. 

Remains,  then,  the  final  question  of  the  relative  im- 
portance as  stimuli  to  save  and  invest,  of  property  rights 
and  the  right  to  transfer  such  rights  to  other  individuals 
or  project  control  beyond  one's  own  lifetime.  We  cannot 
enter  here  at  length  into  the  question  of  inheritance.  Still 
more  than  ownership  in  the  strict  sense,  of  which  it  is  no 
essential  part,  inheritance  rests  on  no  conscious  theory, 
but  has  simply  happened.  The  attribute  of  inheritance 
more  or  less  naturally  inheres  in  personal  effects  where  the 
family  system  exists,  and  it  becomes  transferred  to  pro- 
ductive goods  as  these  increase  in  importance,  while  prop- 
erty in  productive  goods  also  enormously  strengthens  and 
isolates  the  private  family  sentiment.  Voluntary  bequest 
outside  the  family  represents  a  later  development  and  in  a 
sense  the  reverse  tendency. 

The  "theory"  of  the  rights  of  transmission  and  bequest 
is,  of  course,  that  they  form  an  important  element  in  the 
inducement  to  conserve  and  accumulate  wealth.  The 
writer  is  extremely  skeptical  as  to  the  soundness  of  this 
view,  but  there  are  considerations  which  must  give  pause 
to  any  rash  advocacy  of  fundamental  change.  The  difficulty , 
again,  is  to  suggest  an  alternative  plan  which  seems  work- 
able. The  public  confiscation  of  wealth  at  the  death  of  the 
owner  raises  the  question  of  what  would  be  done  with  it. 


374  RISK,  UNCERTAINTY,  AND  PROFIT 

For  those  who  are  dubious  of  the  direct  management  of 
productive  enterprise  by  public  agency,  a  leasing  system 
or  sale  at  auction  in  exchange  for  income  rights  in  the  form 
of  debentures  or  the  like  perhaps  offer  a  possible  way  out. 
This  is  much  like  some  of  the  suggestions  of  the  Saint- 
Simonian  school  of  socialists.1  Even  then  the  practical 
problem  of  distributing  the  income  among  the  people  or 
of  its  public  utilization  gives  rise  to  misgivings. 

Somewhat  similar  problems  again  arise  in  connection 
with  the  personal  powers  of  individuals,  which,  as  we  have 
seen,  obstinately  resist  generic  separation  from  material 
goods  in  their  economic  bearings.  Innate  ability,  in  the 
sense  in  which  there  is  such  a  thing,  is  inevitably  hereditary, 
and  nothing  can  be  done  about  it  except  to  modify  the 
conception  of  the  individual's  property  rights  in  his  own 
powers.  But  culture  in  all  its  subtle  significance,  as  well  as 
education  and  training  in  their  cruder  forms,  are  also  more 
or  less  transmissible  and  more  or  less  subject  to  voluntary 
bestowal,  and  the  factor  of  personal  influence  or  "pull" 
can  by  no  means  be  left  out  of  account.  The  significance  of 
control  over  these  things  is  very  great  and  would  probably 
be  multiplied  rather  than  diminished  in  a  society  which 
abolished  property  in  material  things.  It  seems  that  real 
equality  of  opportunity,  a  true  merit  system,  is  hardly 
conceivable,  and  that  no  very  close  approach  to  such  a 
consummation  can  be  expected  in  connection  with  the 
private  family.  Plato,  of  course,  recognized  this  fact, 
which  most  of  his  modern  successors  have  a  tendency  to 
blink. 

The  ultimate  difficulties  of  any  arbitrary,  artificial, 
moral,  or  rational  reconstruction  of  society  center  around 
the  problem  of  social  continuity  in  a  world  where  indi- 
viduals are  born  naked,  destitute,  helpless,  ignorant,  and 
untrained,  and  must  spend  a  third  of  their  lives  in  ac- 

1  See  also  Alvin  S.  Johnson,  "The  Public  Capitalization  of  the  In- 
heritance Tax,"  Journal  of  Political  Economy,  February,  1914. 


SOCIAL  ASPECTS  375 

quiring  the  prerequisites  of  a  free  contractual  existence. 
The  distribution  of  control,  of  personal  power,  position, 
and  opportunity,  of  the  burden  of  labor  and  of  uncertainty, 
and  of  the  material  produce  of  social  industry  cannot  easily 
be  radically  altered,  whatever  we  may  think  ideally  ought 
to  be  done.  The  fundamental  fact  about  society  as  a  going 
concern  is  that  it  is  made  up  of  individuals  who  are  born 
and  die  and  give  place  to  others;  and  the  fundamental  fact 
about  modern  civilization  is  that  it  is  dependent  upon  the 
utilization  of  three  great  accumulating  funds  of  inheritance 
from  the  past,  material  goods  and  appliances,  knowledge 
and  skill,  and  morale.  Besides  the  torch  of  life  itself,  the 
material  wealth  of  the  world,  a  technological  system  of 
vast  and  increasing  intricacy  and  the  habituations  which 
fit  men  for  social  life  must  in  some  manner  be  carried  for- 
ward to  new  individuals  born  devoid  of  all  these  things  as 
older  individuals  pass  out.  The  existing  order,  with  the 
institutions  of  the  private  family  and  private  property 
(in  self  as  well  as  goods),  inheritance  and  bequest  and  pa- 
rental responsibility,  affords  one  way  for  securing  more  or 
less  tolerable  results  in  grappling  with  this  problem.  They 
are  not  ideal,  nor  even  good;  but  candid  consideration  of 
the  difficulties  of  radical  transformation,  especially  in  view 
of  our  ignorance  and  disagreement  as  to  what  we  want, 
suggests  caution  and  humility  in  dealing  with  reconstruc- 
tion proposals. 


THE  END 


INDEX 


INDEX 


Adriance,  W.  M.,  109,  112. 

Analysis,  identical  with  static 
method,  17. 

Anderson,  B.  M.,  Jr.,  64  n.t  85. 

Assumptions  of  economics,  impor- 
tance of  making  explicit,  10  ff . 

Bagehot,  W.,  5,  25. 
Balfour,  Jas.,  221,  n.  2. 
Borel,  E.,  221  n. 
Bowley,  A.  L.,  212  n. 

Cairnes,  J.  E.,  10,  123. 

Cannon,  E.,  24  n.,  150,  365. 

Capital  and  capital  goods,  166,  n.  1, 
321  ff.;  created  by  banks  through 
forced  saving,  165,  n.  2;  is  homo- 
geneous with  its  product,  166  n. 

Capitalization,  138,  330. 

Carver,  T.  N.,  31,  n.  4,  109,  124, 
365.  ^ 

Choice,  theory  of,  chap,  in;  prin- 
ciple of,  64,  65. 

Clark,  J.  B.,  15,  16,  22  n.,  24,  31, 
32  ff.,  108,  124  n.,  142  n.,  159  n., 
179  n. 

Clark,  J.  M.f  62  n.,  109,  179  n 
263  n. 

Competition,  absence  of  profit  test 
of  perfect,  18  ff.;  prerequisites  for 
perfect,  76-86. 

Comte,  A.,  8  n. 

Control,  means  meeting  uncer- 
tainty, 259,  271,  288  f.;  and 
knowledge  commonly  indirect, 
287  ff.;  chap.  x. 

Cooley,  C.  H.,  208,  n.  2. 

Cost,  equal  to  value  with  uncer- 
tainty absent,  71,  86;  increases 
with  supply  under  static  condi- 
tions, 90  f.,  92  n.,  121  f.;  pain  cost 
and  opportunity.cost  identical,  73. 

Cournot,  A.,  6. 

Crusoe  economy,  74  ft. 

Davenport,  H.  J.,  31,  n.  4,  64  n., 
81  n.,  105,  109,  124  n.t  183  n., 
336  n. 


Deduction,  and  induction,  7  n. 
Deductive  method,  place  in  eco- 
nomics, chap,  i;  6,  10. 
Dewey,  John,  16. 

Diminishing  productivity,  104,  119. 
Diminishing  returns,  98  ff.,  119. 
Distribution,  theory  of,  chap.  rv. 
Du  Bois-Reymond,  E.,  201  n. 

Economics,  classification  of  prin- 
cipal problems,  134. 

Edgeworth,  F.  Y.,  64  n.f  69  n.,  82 
n.,  212  n.,  224. 

Elderton,  W.  P.,  212  n. 

Ely,  R.  T.,  31,  n.  4. 

Engels,  F.,  27. 

Enterprise  versus  handicraft,  244. 

Entrepreneurship,  elements  of,  270^ 
282  f. 

Equilibrium,  17;  all  phases  of  pro- 
gress tend  toward,  170  ff . 

Equilibrium  levels,  wages  and  in- 
terest indefinitely  remote,  155, 
164  n.,  166  ff. 

Error  in  judgment  distinguished 
from  risk,  225  f. 

Factors  of  production,  tripartite 
division  illicit,  123  ff.;  must  be 
defined  in  physical  terms,  116; 
not  adequately  differentiated  by 
conditions  of  supply,  159  ff.,  153 
n.,  163  n. 

Family  and  free  enterprise,  374  f. 

Fetter,  F.  A.,  31,  n.  4,  64  n. 

Fisher,  Arne,  222  n. 

Fisher,  I.,  31,  n.  4, 220  n.,  227, 239  n. 

Freedom  versus  free  contract,  351  ff . 

Friction,  economic,  342  ff . 

Geddes,  Patrick,  54  n. 
Godwin,  Wm.,  153,  n.  2. 
Gross,  G.,  22  n.,  28,  29,  30. 

Haney,  L.  H.,  183  n.,  254  n. 
Hawley,  F.  B.,  31,  41  ff .,  184, 298  n., 

364. 
Haynes,  John,  199  n.f  362 


380 


INDEX 


History  of  profit  theory,  chap.  n. 
Hobson,  J.  A.,  31,  110,  113,  159  n. 
Huebner,  S.,  249  n. 
Hufeland,  26. 

Imputation,  theory  of,  chap.  iv. 

Inductive  method,  chap.  I. 

Inheritance  and  saving,  373. 

Insurance,  theory  of,  247  ff . 

Interest,  theory  of,  161  ff.;  chap, 
xi ;  probably  absent  under  static 
conditions,  168,  169;  contract 
alternative  to  a  lease,  169;  dis- 
tinguished from  rent,  328  f. 

James,  Wm.,  210  n. 
Jevons,  W.  S.,  6,  64  n.,  132  n. 
Johnson,  Alvin  S.,  31,  n.  4,  39  f., 
124  n.,  161  n.,  187,  374. 

Keynes,  J.  N.,  10.1 
King,  W.  I.,  364,  n.  3. 
Kleinwachter,  Fr.,  28,  29,  30. 
Korner,  A.,  28  n.,  29. 

Landry,  A.,  110. 

Laplace,  P.  S.,  222  n. 

Large-scale  business  reduces  risk, 

252  ff. 
Lassalle,  F.,  27,  153,  n.  2. 
Lavergne,  B.,  30  n.,  187. 
Lavington,  F.,  199  n. 
Leroy-Beaulieu,  P.  P.,  Sr.,  31  n. 
Leslie,  T.  E.  C,  199  n. 
Leverhulme,  Lord,  127  n. 

Mackenzie,  J.  S.,  5. 
Macvane,  S.  M.,  31  n. 
McCulloch,  J.  R.,  24. 
Maine,  Sir  H.  S.,  351  n. 
Malthus,  T.  R.,  24,  154. 
Manager,  the  salaried,  chap.  X. 
Mangoldt,  H.  v.,  22  n.,  25,  26,  27, 

362. 
Marshall,  Alfred,   15,   16,  25,  31, 

71,  n.  3,  82  n.,  142  n.,  165,  211  n. 
Marx,  K.,  27. 
Mataja,  V.,  22  n.,  28. 
Menger,  K.,  28,  29,  110. 
Merril,  J.  C.  F.,  362  n. 
Mill,  John  S.,  6,  10,  24,  152,  154, 

184,  363. 
Mitchell,  W.  C,  54  n.,  64  n. 
Mithoff,  Th.,  28,  29. 


Monopoly,  184  ff.;  is  economically 
productive,  186,  188  ff.;  univer- 
sal tendency  toward,  190  ff. 

Motives,  always  relative,  59;  not 
mainly  consumption,  52  ff.,  319, 
331  ff.,  369. 

Moulton,  H.  G.,  165,  n.  2,  336  n. 

Organization,  central  problem  of 
economics,  54  ff . 

Padan,  R.  S.,  110  n.,  111. 

Palgrave.  R.  H.  I.,  24  n. 

Pareto,  V.,  6,  14. 

Patten,  S.  N.,  69  n. 

Pearson,  K.,  212,  n.  1,  221  n. 

Pierstorff,  J.,  22  n.,  28. 

Pigou,  A.  C,  199  n. 

Plato,  374. 

Poincar6,  R.,  221,  n.  2. 

Porte,  M.,  22  n.,  364  n. 

Price,  theory,  classification  of  main 
problems,  134. 

Probability,  212  ff . ;  types  of,  214  ff ., 
223  ff. 

Productive  service  supply  and  de- 
mand under  static  conditions, 
117  ff. 

Productivity  theory,  statement, 
and  criticism,  chap,  iv;  objec- 
tions considered,  109-13. 

Productivity  is  an  organization  con- 
cept, has  no  moral  significance, 
109, 178;  identical  with  causality, 
112,  113  f. 

Profit,  history  of  theories,  chap,  n; 
alleged  tendency  to  zero,  361  ff . ; 
author's  theory,  chap,  ix;  mark 
of  imperfect  competition,  18  ff.; 
probably  negative  in  the  aggre- 
gate, 361  ff.,  364;  relation  to 
other  shares,  302  ff. 

Progress,  theory  of,  with  uncer- 
tainty absent,  chap,  v;  modes  or 
factors  of,  145-47;  uncertainty 
and,  chap.  xi.      ^ 

Promotion,  257. 

Property,  meaning,  352, 566;  owner- 
ship a  social  function,  359  ff. 

Psychological  theory  of  interest  does 
not  fit  real  conditions,  136,  167. 

Read,  Samuel,  26  n. 
Resources,  65. 


INDEX 


381 


Ricardo,  D.,  27. 

Riedel,  26. 

Risk  versus  uncertainty,  19,  225  f . ; 
chap,  vn ;  to  person  versus  ma- 
terial property,  355  ff . 

Rodbertus,  J.,  27,  28. 

Roscher,  W.,  26. 

Ross,  E.  A.,  199  n.,  362. 

Rossi,  26  n. 

Saving,  motives  of,  137  ff.,  162  f. 

Say,  J.  B.,  25. 

Schaffle,  V.,  26. 

Schonberg,  G.,  28. 

Schroeder,  E.  A.,  28  n. 

Schumpeter,  J.,  15,  24,  33,  n.  4. 

Seager,  H.  R.,  31,  n.  4. 

Seligman,  E.  R.  A.,  31,  n.  4,  85  n. 

Seneuil,  Courcelle,  25. 

Senior,  N.  W.,  365. 

Sidgwick,  H.,  132  n. 

Smith,  Adam,  24,  27,  365. 

Speculation,  theory  of,  255  ff.;  af- 
fects consolidation  of  risk  as  well 
as  specialization,  257. 

Spencer,  H.,  132,  n.  2,  351  n. 

Static  method,  16. 

Static  state,  specifications  of,  145- 
47. 

Stuart,  H.  W.,  54  n. 

Supply  curves,  84. 

Taussig,  F.  W.,  31,  n.  4,  112,  321, 

n.  2. 
Taylor,  F.  M.,  31,  n.  4,  99  n.,  104, 


110;  versus  Wieser  on  productiv- 
ity, 110  n.,  126,  362,  363. 

Taylor,  H.  C,  286  n. 

Thomas,  W.  I.,  333  n. 

Thunen,  H.  von,  26. 

Time  preference,  fallacy  of,  130  ff . 

Tufts,  J.  H.,  333  n. 

Uncertainty  versus  risk,  19;  chap, 
vn ;  methods  of  meeting,  239  f.; 
elements  of,  202,  241  ff.;  meeting 
uncertainty  the  essence  of  con- 
trol, 259,  271,  288  f.;  distribu- 
tion of,  300;  social  policy  in  re- 
lation to,  chap,  xn ;  how  far  irk- 
some, 347  ff. 

Utility,  61  f.;  utility  and  disutility 
relative,  63;  a  rate,  59,  70. 

Veblen,  T.,  28  n.,  188  n.,  334  n. 
Venn,  J.,  224. 

Walker,  F.  A.,  25,  31,  159  n. 
Walras,  L.,  6. 
Wants,  Production  of,  339. 
Watkins,  M.  W.,  165,  n.  2. 
Wicksteed,  P.  H.,  14,  64  n.,  108  n., 

110,  135  n. 
Wieser,  Fr.  v.,  104,  n.  2,  110. 
Willett,  A.  H.,  39  f.,  189  n.,  263  n., 

266  n.,  362. 
Wirminghaus,  A.,  28  n. 

Young,  A.  A.,  30  n.,  159  n.,  188  n. 

Zuns,  E.,  28  n. 


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